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SECURITIES AND EXCHANGE COMMISSIONCCP dated July 11, 2016; Brent J. Fields, Secretary, Commission,...
Transcript of SECURITIES AND EXCHANGE COMMISSIONCCP dated July 11, 2016; Brent J. Fields, Secretary, Commission,...
SECURITIES AND EXCHANGE COMMISSION
(Release No. 34-78683; File No. SR-FINRA-2015-056)
August 25, 2016
Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Order Approving
a Proposed Rule Change to Adopt FINRA Rule 2030 and FINRA Rule 4580 to Establish “Pay-
To-Play” and Related Rules
I. Introduction
On December 16, 2015, Financial Industry Regulatory Authority, Inc. (“FINRA”) filed
with the Securities and Exchange Commission (“SEC” or “Commission”), pursuant to Section
19(b)(1) of the Securities Exchange Act of 1934 (“Act” or “Exchange Act”)1 and Rule 19b-4
thereunder,2 a proposed rule change to adopt FINRA Rules 2030 (Engaging in Distribution and
Solicitation Activities with Government Entities) and 4580 (Books and Records Requirements
for Government Distribution and Solicitation Activities) to establish “pay-to-play”3 and related
rules that would regulate the activities of member firms that engage in distribution or solicitation
activities for compensation with government entities on behalf of investment advisers. Member
firms serving this role—sometimes referred to as “placement agents” or “solicitors” (collectively
referred to herein as “placement agents”)—assist investment advisers with obtaining advisory
business from such entities. In this context, pay-to-play has historically presented a problem,
including when investment advisers retain placement agents who have made contributions to
government officials who are responsible for, or can influence the outcome of, the selection
1 15 U.S.C. 78s(b)(1).
2 17 CFR 240.19b-4.
3 “Pay-to-play practices,” “play-to-play arrangements” or “play-to-play activities,” as
referred to throughout this order, typically involve a person making cash or in-kind
political contributions (or soliciting or coordinating others to make such contributions) to
help finance the election campaigns of state or local officials or bond ballot initiatives as
a quid pro quo for the receipt of government contracts.
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process for investment advisers. When investment advisers are chosen on the basis of a
placement agent’s political contributions, rather than on, for example, the adviser’s merit,
performance, or costs, the market and selection process for advisers becomes distorted.
Ultimately, pay-to-play harms investors and the public interest if government entities, including
public pension plans, and their beneficiaries receive inferior services or pay higher fees.
The proposed rule change was published for comment in the Federal Register on
December 30, 2015.4 The Commission received ten comment letters, from nine different
commenters, in response to the Notice.5 On February 8, 2016, FINRA extended the time period
by which the Commission must approve the proposed rule change, disapprove the proposed rule
change, or institute proceedings to determine whether to approve or disapprove the proposed rule
4 See Exchange Act Rel. No. 76767 (Dec. 24, 2015), 80 FR 81650 (Dec. 30, 2015) (File
No. SR-FINRA-2015-056) (“Notice”).
5 See Letters from David Keating, President, Center for Competitive Politics (“CCP”),
dated Jan. 20, 2016 (“CCP Letter 1”); Clifford Kirsch and Michael Koffler, Sutherland
Asbill & Brennan LLP, for the Committee of Annuity Insurers (“CAI”), dated Jan. 20,
2016 (“CAI Letter 1”); Clifford Kirsch and Michael Koffler, Sutherland Asbill &
Brennan LLP, for the CAI, dated Feb. 5, 2016 (“CAI Letter 2”); David T. Bellaire,
Executive Vice President and General Counsel, Financial Services Institute (“FSI”),
dated Jan. 20, 2016 (“FSI Letter 1”); Tamara K. Salmon, Assistant General Counsel,
Investment Company Institute (“ICI”), dated Jan. 20, 2016 (“ICI Letter”); Patrick J
Moran, Esq., dated Dec. 29, 2015 (“Moran Letter”); Gary A. Sanders, Counsel and Vice
President, National Association of Insurance and Financial Advisors (“NAIFA”), dated
Jan. 20, 2016 (“NAIFA Letter”); Judith M. Shaw, President, North American Securities
Administrators Association, Inc. (“NASAA”), dated Jan. 20, 2016 (“NASAA Letter”);
Hugh D. Berkson, President, Public Investors Arbitration Bar Association (“PIABA”),
dated Jan. 20, 2016 (“PIABA Letter”); and H. Christopher Bartolomucci and Brian J.
Field, Bancroft PLLC, for the New York Republican State Committee and the Tennessee
Republican Party (“State Parties”), dated Jan. 20, 2016 (“State Parties Letter 1”). The
comment letters filed with the Commission in connection with the proposed rule change
are available at: http://www.sec.gov/comments/sr-finra-2015-056/finra2015056.shtml.
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change to March 29, 2016.6 On March 28, 2016, FINRA filed a letter with the Commission
stating that it considered the comments received by the Commission in response to the Notice,
and that FINRA is not intending to make changes to the proposed rule text in response to the
comments.7
On March 29, 2016, pursuant to delegated authority, the Commission issued an order
instituting proceedings pursuant to Section 19(b)(2)(B) of the Act8 to determine whether to
approve or disapprove the proposed rule change, and solicited additional comment.9 The
Commission received an additional four comments regarding the proceedings,10
including two
letters requesting an opportunity to make an oral presentation in the proceedings.11
On July 6,
2016, FINRA submitted a letter responding to all comments and to the Order Instituting
6 See Letter from Victoria Crane, Associate General Counsel, FINRA, to Lourdes
Gonzalez, Assistant Chief Counsel—Sales Practices, Division of Trading and Markets,
Commission, dated Feb. 8, 2016.
7 See Letter from Victoria Crane, Associate General Counsel, FINRA, to Brent J. Fields,
Secretary, Commission, dated Mar. 28, 2016 (“FINRA Response Letter 1”).
8 15 U.S.C. 78s(b)(2)(B).
9 See Securities Exchange Act Release No. 77465 (Mar. 29, 2016), 81 FR 19260 (Apr. 4,
2016) (“Order Instituting Proceedings”).
10 See Letters from David T. Bellaire, Executive Vice President and General Counsel, FSI,
dated Apr. 27, 2016 (“FSI Letter 2”); Jason Torchinsky, Holtzman Vogel Josefiak
Torchinsky PLLC, on behalf of the Georgia Republican Party and the State Parties, dated
April 12, 2016, filed April 21, 2016 (“State Parties Letter 2”); Allen Dickerson, Legal
Director, CCP, dated April 21, 2016 (“CCP Letter 2”); Allen Dickerson, Legal Director,
CCP, dated April 15, 2016 (“CCP Letter 3”).
11 See CCP Letter 2; State Parties Letter 2. The Commission denied both requests. See
Letter from Brent J. Fields, Secretary, Commission, to Allen Dickerson, Legal Director,
CCP dated July 11, 2016; Brent J. Fields, Secretary, Commission, to Jason Torchinsky,
Holtzman Vogel Josefiak Torchinsky PLLC, on behalf the State Parties, dated July 11,
2016.
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Proceedings.12
On June 21, 2016, FINRA extended the time period by which the Commission
must determine whether to approve or disapprove the proposed rule change to August 26, 2016.13
This order approves the rule change as proposed. Section II provides an overview of the
rule and summarizes the rule as described by FINRA in its filing and as published in the Notice,
Section III is a summary of the comments received and FINRA’s responses, and Section IV
contains the Commission’s findings in approving the proposal.
II. Description of the Proposed Rule Change14
As described more fully in the Notice, FINRA modeled proposed Rule 203015
on the
Commission’s Rule 206(4)-5 under the Investment Advisers Act of 1940 (“Advisers Act”),
which addresses pay-to-play practices by investment advisers (the “SEC Pay-to-Play Rule”).16
12
See Letter from Victoria Crane, Associate General Counsel, FINRA, to Brent J. Fields,
Secretary, Commission, dated July 6, 2016 (“FINRA Response Letter 2”). Both of
FINRA’s Responses Letters are available on FINRA’s website at http://www.finra.org, at
the principal office of FINRA, and at the Commission’s Public Reference Room.
13 See Letter from Victoria Crane, Associate General Counsel, FINRA, to Lourdes
Gonzalez, Assistant Chief Counsel—Sales Practices, Division of Trading and Markets,
Commission, dated June 21, 2016.
14 The proposed rule change, as described in Item II, is excerpted, in part, from the Notice,
which was substantially prepared by FINRA. See supra note 4. A more detailed
description of the proposed rule change is in the Notice.
15 See Notice, 80 FR at 81650–51 (citing Advisers Act Release No. 3043 (July 1, 2010), 75
FR 41018 (July 14, 2010) (Political Contributions by Certain Investment Advisers)
(‘‘SEC Pay-to-Play Rule Adopting Release’’)).
16 FINRA also published the proposed rule change in Regulatory Notice 14-50 (Nov. 2014)
(“Regulatory Notice 14-50”) and sought comment on the proposal. FINRA states that
commenters were generally supportive of the proposed rule change, but also expressed
some concerns. As such, FINRA revised the proposed rule change as published in
Regulatory Notice 14-50 in response to those comments. As described more fully in the
Notice, FINRA believes that the revisions it made more closely align FINRA’s proposed
rule with the SEC Pay-to-Play Rule and should help reduce cost and compliance burden
concerns raised by commenters. See Notice, 80 FR at 81651 n.16.
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The SEC Pay-to-Play Rule, in part, prohibits any investment adviser covered under the rule17
or
any of its covered associates from providing or agreeing to provide, directly or indirectly,
payment to any person to solicit a government entity for investment advisory services on behalf
of such investment adviser unless such person is a “regulated person,”18
as defined under the
rule, or an executive officer, general partner, managing member, or employee of the investment
adviser.19
A “regulated person,” as defined in the SEC Pay-to-Play Rule, includes a registered
broker-dealer, provided that: (a) FINRA rules prohibit member firms from engaging in
distribution or solicitation activities if certain political contributions have been made to certain
public officials; and (b) the Commission finds, by order, that such rules impose substantially
equivalent or more stringent restrictions on member firms than the SEC Pay-to-Play Rule
imposes on investment advisers and that such rules are consistent with the objectives of the SEC
Pay-to-Play Rule.20
In light of this regulatory framework, FINRA proposed its own pay-to-play rule to enable
its member firms to continue to engage in distribution and solicitation activities for
compensation with government entities on behalf of investment advisers, while subjecting its
17
The SEC Pay-to-Play Rule applies to investment advisers registered or required to be
registered with the Commission, foreign private advisers that are unregistered in reliance
on Section 203(b)(3) of the Advisers Act, and exempt reporting advisers as defined in
Rule 204-4(a) under the Advisers Act. See 17 CFR 275.206(4)-5(a)(2).
18 See Notice, 80 FR at 81650 n.6, 81656. See also 17 CFR 275.206(4)-5(a)(2)(i)(A).
19 See 17 CFR 275.206(4)-5(a)(2)(i)(B) (or, in each case, a person with a similar status or
function to an executive officer, general partner, or managing member of the investment
adviser).
20 See Notice, 80 FR at 81650 n.6 (citing 17 CFR 275.206(4)-5(f)(9)). The definition of
“regulated person” also includes SEC-registered investment advisers and SEC-registered
municipal advisors, subject to specified conditions. The Commission amended the SEC
Pay-to-Play Rule to add SEC-registered municipal advisors to the definition of “regulated
persons.” See Rules Implementing Amendments to the Investment Advisers Act of 1940,
Investment Advisers Act Rel. No. 3221 (June 22, 2011), 76 FR 42950 (July 19, 2011).
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member firms to appropriate safeguards that will discourage them from engaging in pay-to-play
practices.21
Because one of the objectives of FINRA’s proposal is to satisfy the “regulated
person” definition in the SEC Pay-to-Play Rule, the elements of and terms used in FINRA’s
proposal are substantially equivalent to and consistent with the objectives of the SEC Pay-to-
Play Rule.22
As discussed below, this threshold objective precludes many of the modifications
proposed by commenters given that a more permissive FINRA proposal would not meet the
stringency requirements of the SEC Pay-to-Play Rule. FINRA believes that its proposed rule
would establish a comprehensive regime to regulate the activities of its member firms that
engage in distribution or solicitation activities with government entities on behalf of investment
advisers, and would impose substantially equivalent restrictions on FINRA member firms
engaging in distribution or solicitation activities to those that the SEC Pay-to-Play Rule imposes
on investment advisers.23
Furthermore, FINRA’s proposed Rule 4580 would impose recordkeeping requirements
on FINRA member firms in connection with its pay-to-play rule that would allow examination of
member firms’ books and records for compliance with Rule 2030.24
FINRA believes that
21
See Notice, 80 FR at 81651, 81656.
22 On August 25, 2016, the Commission issued a notice stating that it intends to issue an
order pursuant to Section 206 of the Advisers Act and SEC Pay-to-Play Rule 206(4)-5
finding that FINRA’s proposed Rule 2030 (i) imposes substantially equivalent or more
stringent restrictions on broker-dealers than the SEC Pay-to-Play Rule imposes on
investment advisers and (ii) is consistent with the objectives of the SEC Pay-to-Play
Rule.
23 See Notice, 80 FR at 81651, 81656.
24 See id. at 81651, 81655–56.
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proposed Rule 4580 is consistent with similar recordkeeping requirements imposed on
investment advisers in connection with the SEC Pay-to-Play Rule.25
The following is an overview of the key provisions in FINRA’s proposed rules, as
described by FINRA in the Notice.
A. Proposed Rule 2030(a): Limitation on Distribution and Solicitation Activities
Proposed Rule 2030(a) would prohibit a covered member from engaging in distribution
or solicitation activities for compensation with a government entity on behalf of an investment
adviser that provides or is seeking to provide investment advisory services to such government
entity within two years after a contribution to an official of the government entity is made by the
covered member or a covered associate, including a person who becomes a covered associate
within two years after the contribution is made.26
FINRA states that the terms and scope of the
prohibitions in proposed Rule 2030(a) are modeled on the SEC Pay-to-Play Rule.27
According
to FINRA, the two-year time-out period is intended to discourage covered members from
participating in pay-to-play practices by requiring a cooling-off period during which the effects
of a political contribution on the selection process can be expected to dissipate.28
The following is an overview of some of the key terms used in FINRA’s proposed Rule
2030, as discussed by FINRA in its filing and published in the Notice or as defined in proposed
Rule 2030(g).
25
See id. at 81655 n.60 (citing Advisers Act Rule 204-2(a)(18) and (h)(1)).
26 See Notice, 80 FR at 81651.
27 See id. at 81651. See also id. at 81651 n.19 (citing 17 CFR 275.206(4)-5(a)(1)).
28 Notice, 80 FR at 81651, 81659.
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1. Covered Members
The SEC Pay-to-Play Rule includes within its definition of “regulated person” SEC-
registered municipal advisors, subject to specified conditions.29
Specifically, the SEC Pay-to-
Play Rule prohibits an investment adviser from providing or agreeing to provide, directly or
indirectly, payment to an SEC-registered municipal advisor unless the municipal advisor is
subject to a Municipal Securities Rulemaking Board (“MSRB”) pay-to-play rule.30
FINRA addresses the interplay between its proposed rule and the application of the
MSRB’s municipal advisor pay-to-play rule by exempting from the definition of “covered
member” a member when it is “engaging in activities that would cause the member to be a
municipal advisor as defined in Exchange Act Section 15B(e)(4), SEA Rule 15Ba1-1(d)(1)
through (4) and other rules and regulations thereunder.”31
FINRA states that a member firm that
solicits a government entity for investment advisory services on behalf of an unaffiliated
investment adviser may be required to register with the SEC as a municipal advisor as a result of
such activity.32
Under such circumstances, FINRA notes that the MSRB rules applicable to
municipal advisors, including the pay-to-play rule adopted by the MSRB,33
would apply to the
29
See 17 CFR 275.206(4)-5(a)(2)(i)(A) and 17 CFR 275.206(4)-5(f)(9).
30 See supra note 29.
31 Proposed Rule 2030(g)(4). See also Notice, 80 FR at 81652 (explaining that the SEC
Pay-to-Play Rule includes within its definition of “regulated person” SEC-registered
municipal advisors, subject to specified conditions, and prohibits an investment adviser
from providing or agreeing to provide, directly or indirectly, payment to an SEC-
registered municipal advisor unless the municipal advisor is subject to a MSRB pay-to-
play rule).
32 See Notice, 80 FR at 81652.
33 On February 17, 2016, the MSRB published a regulatory notice announcing that its pay-
to-play rule was deemed approved pursuant to section 19(b)(2)(D) of the Exchange Act
on February 13, 2016 and that the effective date of the rule is August 17, 2016. See
Amendments to MSRB Rule G-37 on Political Contributions and Prohibitions on
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member firm.34
On the other hand, if the member firm solicits a government entity on behalf of
an affiliated investment adviser, such activity would not cause the firm to be a municipal
advisor.35
Under such circumstances, the member firm would be a “covered member” subject to
the requirements of proposed Rule 2030.36
This distinction is the result of the definitions of
“municipal advisor” and “solicitation of a municipal entity or obligated person” in the Exchange
Act, which only covers a person who is not affiliated with the broker, dealer, municipal securities
dealer, municipal advisor, or investment adviser for whom the person is soliciting.37
Municipal Securities Business and Related Amendments are Deemed Approved under the
Securities Exchange Act of 1934, Regulatory Notice 2016-06, dated February 17, 2016
(the “MSRB Regulatory Notice”), available at
http://www.msrb.org/~/media/Files/Regulatory-Notices/Announcements/2016-
06.ashx?n=1.
34 See Notice, 80 FR at 81652.
35 See id.
36 See id. FINRA also notes that a person that is registered under the Exchange Act as a
broker-dealer and municipal advisor, and under the Advisers Act as an investment
adviser could potentially be a “regulated person” for purposes of the SEC Pay-to-Play
Rule and that such a regulated person would be subject to the rules that apply to the
services the regulated person is performing. See id. at n.24.
37 Exchange Act Section 15B(e)(4) provides that a “municipal advisor” includes a person
that undertakes solicitation of a municipal entity or obligated person. 15 U.S.C. 78o-
4(e)(4). Exchange Act Section 15B(e)(9) provides that the term “solicitation of a
municipal entity or obligated person” means “a direct or indirect communication with a
municipal entity or obligated person made by a person, for direct or indirect
compensation, on behalf of a broker, dealer, municipal securities dealer, municipal
advisor, or investment adviser (as defined in section 202 of the Investment Advisers Act
of 1940) that does not control, is not controlled by, or is not under common control with
the person undertaking such solicitation for the purpose of obtaining or retaining an
engagement by a municipal entity or obligated person of a broker, dealer, municipal
securities dealer, or municipal advisor for or in connection with municipal financial
products, the issuance of municipal securities, or of an investment adviser to provide
investment advisory services to or on behalf of a municipal entity.” 15 U.S.C. 78o-
4(e)(9).
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2. Distribution Activities
With respect to the triggering activities for FINRA’s proposed Rule 2030(a), FINRA
states that, based on the definition of “regulated person” in the SEC Pay-to-Play Rule,38
it is
proposing a rule that prohibits its member firms from engaging in distribution activities (as well
as solicitation activities) for compensation with government entities for two years after certain
political contributions have been made to certain officials.39
FINRA also notes, in response to
certain comments discussed below, that certain language in the SEC Pay-to-Play Rule Adopting
Release further supports the inclusion of distribution activities by broker-dealers in FINRA’s
proposed Rule 2030.40
FINRA explains that the proposed rule would not apply to distribution activities related
to registered investment companies that are not investment options of a government entity’s plan
or program because in these circumstances a member firm is not providing or seeking to provide
investment advisory services to a government entity.41
Therefore, the proposed rule would apply
38
A “regulated person,” as defined in the SEC Pay-to-Play Rule, includes a FINRA
member firm, provided that: (a) FINRA rules “prohibit member firms from engaging in
distribution or solicitation activities if certain political contributions have been made;”
and (b) “[t]he Commission finds, by order, that such rules impose substantially equivalent
or more stringent restrictions on broker-dealers than [the SEC Pay-to-Play Rule] imposes
on investment advisers and that such rules are consistent with the objectives of [the SEC
Pay-to-Play Rule].” 17 CFR 275.206(4)-5(f)(9)(ii).
39 See Notice, 80 FR at 81660–61 (explaining that FINRA believes its proposed rule must
apply to member firms engaging in distribution activities and that FINRA did not revise
the proposed rule to remove references to the term “distribution” as requested by
comments received in response to Regulatory Notice 14-50).
40 See Notice, 80 FR at 81660. See also id. at 81661 n.103 (citing SEC Pay-to-Play Rule
Adopting Release, 75 FR at 41040 n.298 where, according to FINRA, the Commission
“clarif[ied] under what circumstances distribution payments would violate the SEC’s
Pay-to-Play Rule”).
41 See Notice, 80 FR at 81661 n.106 (explaining that, although the proposed rule would not
apply to distribution activities relating to all registered pooled investment vehicles,
11
to distribution activities involving unregistered pooled investment vehicles such as hedge funds,
private equity funds, venture capital funds, collective investment trusts, and registered pooled
investment vehicles such as mutual funds, but only if those registered pools are an investment
option of a participant-directed plan or program of a government entity.42
FINRA also notes
that, consistent with the SEC Pay-to-Play Rule, to the extent mutual fund distribution fees are
paid by the fund using fund assets pursuant to a 12b-1 plan, such payments generally would not
constitute payments by the fund’s investment adviser.43
However, if the adviser pays for the
fund’s distribution out of its “legitimate profits,” the proposed rule would generally be
implicated.44
3. Solicitation Activities
FINRA states that, consistent with the SEC Pay-to-Play Rule, proposed Rule 2030(g)(11)
defines the term “solicit” to mean:
pursuant to proposed Rule 2030(e) “[i]t shall be a violation of this Rule for any covered
member or any of its covered associates to do anything indirectly that, if done directly,
would result in a violation of this Rule”).
42 See id. at 81661. See also id. at 81651 n.17 and 81654 n.46.
43 See id. at 81661 n.103. See also SEC Pay-to-Play Rule Adopting Release, 75 FR at
41040 n.298 (discussing how broker-dealers may be compensated by advisers according
to distribution arrangements and noting that “[m]utual fund distribution fees are typically
paid by the fund pursuant to a 12b-1 plan, and therefore generally would not constitute
payment by the fund’s adviser. As a result, such payments would not be prohibited [under
the SEC Pay-to-Play Rule] by its terms”).
44 See Notice, 80 FR at 81661 n.103 (noting, among other things, that “for private funds,
third parties are often compensated by the investment adviser or its affiliated general
partner”). For a discussion of a mutual fund adviser’s ability to use “legitimate profits”
for fund distribution, see Investment Company Act of 1940 Release No. 11414 (Oct. 28,
1980), 45 FR 73898 (Nov. 7, 1980) (Bearing of Distribution Expenses by Mutual Funds).
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(A) With respect to investment advisory services, to communicate, directly or indirectly,
for the purpose of obtaining or retaining a client for, or referring a client to, an
investment adviser; and (B) With respect to a contribution or payment, to communicate,
directly or indirectly, for the purpose of obtaining or arranging a contribution or
payment.45
FINRA notes that, although the determination of whether a particular communication
would be a solicitation would depend on the facts and circumstances relating to such
communication, as a general proposition FINRA believes that any communication made under
circumstances reasonably calculated to obtain or retain an advisory client would be considered a
solicitation unless the circumstances otherwise indicate that the communication does not have
the purpose of obtaining or retaining an advisory client.46
4. Investment Advisers
Proposed Rule 2030 would apply to covered members acting on behalf of (as defined in
proposed Rule 2030(g)(7)) any investment adviser registered (or required to be registered) with
the Commission, or unregistered in reliance on the exemption available under Section 203(b)(3)
of the Advisers Act for foreign private advisers, or that is an exempt reporting adviser under
Advisers Act Rule 204-4(a).47
Thus, proposed Rule 2030 would not apply to member firms
acting on behalf of advisers that are registered with state securities authorities instead of the
SEC, or advisers that are unregistered in reliance on exemptions other than Section 203(b)(3) of
the Advisers Act or Advisers Act Rule 204-4(a). The proposed rule’s definition of “investment
adviser” is consistent with the definition of “investment adviser” in the SEC Pay-to-Play Rule.48
45
Notice, 80 FR at 81651 n.18. See also id. at 81653–54 n.40.
46 See id. at 81651 n.18. See also id. at 81653–54 n.40.
47 See Proposed Rule 2030(g)(7).
48 See 17 CFR 275.206(4)-5(a)(1).
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5. Official of a Government Entity
FINRA explains that an “official” (as defined in proposed Rule 2030(g)(8)) of a
“government entity” (as defined in proposed Rule 2030(g)(7))—both of which FINRA states are
consistent with the SEC Pay-to-Play Rule definitions—would include an incumbent, candidate or
successful candidate for elective office of a government entity if the office is directly or
indirectly responsible for, or can influence the outcome of, the hiring of an investment adviser or
has authority to appoint any person who is directly or indirectly responsible for, or can influence
the outcome of, the hiring of an investment adviser.49
FINRA also notes that it is the scope of
authority of the particular office of an official, not the influence actually exercised by the
individual, that would determine whether the individual has influence over the awarding of an
investment advisory contract under the definition.50
FINRA also explains that government
entities would include all state and local governments, their agencies and instrumentalities, and
all public pension plans and other collective government funds, including participant-directed
plans such as 403(b), 457, and 529 plans.51
6. Contributions
Proposed Rule 2030(g)(1) defines “contribution” to mean any gift, subscription, loan,
advance, deposit of money, or anything of value made for the purpose of influencing the election
for a federal, state or local office, and includes any payments for debts incurred in such an
election or transition or inaugural expenses incurred by a successful candidate for state or local
49
See Notice, 80 FR at 81652.
50 See id. (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41029 (discussing the
terms “official” and “government entity”).
51 See Notice, 80 FR at 81652.
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office.52
FINRA states that this definition is consistent with the SEC Pay-to-Play Rule.53
FINRA also states that it would not consider a donation of time by an individual to be a
contribution, provided the covered member has not solicited the individual’s efforts and the
covered member’s resources, such as office space and telephones, are not used.54
FINRA further
states that it would not consider a charitable donation made by a covered member to an
organization that qualifies for an exemption from federal taxation under the Internal Revenue
Code, or its equivalent in a foreign jurisdiction, at the request of an official of a government
entity to be a contribution for purposes of the proposed rule.55
7. Covered Associates
Proposed Rule 2030(g)(2) defines the term “covered associates” to mean:
(A) Any general partner, managing member or executive officer of a covered member, or
other individual with a similar status or function; (B) Any associated person of a covered
member who engages in distribution or solicitation activities with a government entity for
such covered member; (C) Any associated person of a covered member who supervises,
directly or indirectly, the government entity distribution or solicitation activities of a
person in subparagraph (B) above; and (D) Any political action committee controlled by
a covered member or a covered associate.56
FINRA states that, as also noted in the SEC Pay-to-Play Rule Adopting Release,
contributions made to influence the selection process are typically made not by the firm itself,
but by officers and employees of the firm who have a direct economic stake in the business
relationship with the government client.57
For example, contributions by an “executive officer of
52
See id. at 81652.
53 See id. at 81652 n.32. See also id. at 81653.
54 See id. at 81653 n.33 (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41030).
55 See Notice, 80 FR at 81653.
56 Id. at 81653 n.37.
57 See id. (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41031).
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a covered member” (as defined in proposed Rule 2030(g)(5)) would trigger the two-year “time-
out.”58
FINRA also notes that whether a person is an executive officer would depend on his or
her function or activities and not his or her title.59
In addition, FINRA states that a covered
associate would include a PAC controlled by the covered member or any of its covered
associates.60
FINRA explains that it would consider a “covered member” (as defined in
proposed Rule 2030(g)(4)) or its covered associates to have “control” over a PAC if the covered
member or covered associate has the ability to direct or cause the direction of governance or
operations of the PAC.61
B. Proposed Rule 2030(b): Prohibition on Soliciting and Coordinating Contributions
Proposed Rule 2030(b) also would prohibit a covered member or covered associate from
soliciting or coordinating any person or political action committee (“PAC”) to make any: (1)
contribution to an official of a government entity in respect of which the covered member is
engaging in, or seeking to engage in, distribution or solicitation activities on behalf of an
investment adviser; or (2) payment to a political party of a state or locality of a government
entity with which the covered member is engaging in, or seeking to engage in, distribution or
solicitation activities on behalf of an investment adviser.62
FINRA states that this provision is
modeled on a similar provision in the SEC Pay-to-Play Rule63
and is intended to prevent covered
members or covered associates from circumventing the proposed rule’s two-year “time-out” by
58
See Notice, 80 FR at 81653.
59 See id.
60 See id.
61 See id.
62 See id. at 81653–54. See also id. at 81662.
63 See id. at 81654 n.42 (citing 17 CFR 275.206(4)-5(a)(2)).
16
“bundling,” either by soliciting a large number of contributions by employees, or by soliciting
payments to a State or local political party.64
C. Proposed Rule 2030(c): Exceptions
FINRA’s proposed pay-to-play rule contains three exceptions from the proposed rule’s
prohibitions: (1) de minimis contributions; (2) new covered associates; and (3) certain returned
contributions.65
FINRA states that these exceptions are modeled on similar exceptions in the
SEC Pay-to-Play Rule.66
1. De Minimis Contribution Exception
Proposed Rule 2030(c)(1) would except from the rule’s restrictions contributions made
by a covered associate who is a natural person to government entity officials for whom the
covered associate was entitled to vote at the time of the contributions, provided the contributions
do not exceed $350 in the aggregate to any one official per election.67
If the covered associate
was not entitled to vote for the official at the time of the contribution, the contribution must not
exceed $150 in the aggregate per election.68
FINRA states that, consistent with the SEC Pay-to-
Play Rule, under this exception, primary and general elections would be considered separate
elections.69
FINRA also explains that this exception is based on the theory that such
64
See Notice, 80 FR at 81654.
65 See id.
66 See id. at n.51 (citing 17 CFR 275.206(4)-5(b)).
67 See Notice, 80 FR at 81655.
68 See id.
69 See id. at 81655 n.54 (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41034).
17
contributions are typically made without the intent or ability to influence the selection process of
the investment adviser.70
2. Exception for Certain New Covered Associates
The proposed rule would attribute to a covered member contributions made by a person
within two years (or, in some cases, six months) of becoming a covered associate. However,
proposed Rule 2030(c)(2) would provide an exception from the proposed rule’s restrictions for
covered members if a natural person made a contribution more than six months prior to
becoming a covered associate of the covered member unless the covered associate engages in, or
seeks to engage in, distribution or solicitation activities with a government entity on behalf of the
covered member.71
FINRA states that this exception is consistent with the SEC Pay-to-Play
Rule72
and is intended to balance the need for covered members to be able to make hiring
decisions against the need to protect against individuals marketing to prospective employers their
connections to, or influence over, government entities the employer might be seeking as clients.73
FINRA also provides, with respect to the “look back” provisions in the proposed rules generally,
the following illustrations of how the “look back” provisions will work: if, for example, the
contributions were made more than two years (or six months for new covered associates) prior to
the employee becoming a covered associate, the “time-out” has run.74
According to FINRA,
however, if the contribution was made less than two years (or six months, as applicable) from the
time the person becomes a covered associate, the proposed rule would prohibit the covered
70
See Notice, 80 FR at 81655.
71 See id.
72 See id. at 81655 n.55 (citing 17 CFR 275.206(4)-5(b)(2)).
73 See Notice, 80 FR at 81655.
74 See id. at 81656.
18
member that hires or promotes the contributing covered associate from receiving compensation
for engaging in distribution or solicitation activities on behalf of an investment adviser from the
hiring or promotion date until the applicable period has run.75
3. Exception for Certain Returned Contributions
Proposed Rule 2030(c)(3) would provide an exception from the proposed rule’s
restrictions for covered members if the restriction is due to a contribution made by a covered
associate and: (1) the covered member discovered the contribution within four months of it being
made; (2) the contribution was less than $350; and (3) the contribution is returned within 60 days
of the discovery of the contribution by the covered member.76
FINRA explains that, consistent
with the SEC Pay-to-Play Rule, this exception would allow a covered member to cure the
consequences of an inadvertent political contribution.77
The proposed rule also would provide
that covered members with 150 or fewer registered representatives would be able to rely on this
exception no more than two times per calendar year, while covered members with more than 150
registered representatives would be permitted to rely on this exception no more than three times
per calendar year.78
Furthermore, a covered member would not be able to rely on an exception
more than once with respect to contributions by the same covered associate regardless of the
time period, which is consistent with similar provisions in the SEC Pay-to-Play Rule.79
75
See id. at 81655–56.
76 See id. at 81655.
77 See id.
78 See id. FINRA notes that these limitations are consistent with similar provisions in the
SEC Pay-to-Play Rule 206(4)-5(b)(3), although the SEC Pay-to-Play Rule includes
different allowances for larger and smaller investment advisers based on the number of
employees they report on Form ADV. See id. at 81655 n.59.
79 See Notice, 80 FR at 81655.
19
D. Proposed Rule 2030(d): Prohibitions as Applied to Covered Investment Pools
Proposed Rule 2030(d)(1) provides that a covered member that engages in distribution or
solicitation activities with a government entity on behalf of a covered investment pool,80
in
which a government entity invests or is solicited to invest, shall be treated as though the covered
member was engaging in or seeking to engage in distribution or solicitation activities with the
government entity on behalf of the investment adviser to the covered investment pool directly.81
Proposed Rule 2030(d)(2) provides that an investment adviser to a covered investment pool in
which a government entity invests or is solicited to invest shall be treated as though that
investment adviser were providing or seeking to provide investment advisory services directly to
the government entity.82
FINRA states that proposed Rule 2030(d) is modeled on a similar
prohibition in the SEC Pay-to-Play Rule and would apply the prohibitions of the proposed rule to
situations in which an investment adviser manages assets of a government entity through a hedge
fund or other type of pooled investment vehicle.83
Therefore, according to FINRA, the provision
80
See id. at 81654 n.46 (proposed Rule 2030(g)(3) defines a “covered investment pool” to
mean: “(A) Any investment company registered under the Investment Company Act that
is an investment option of a plan or program of a government entity; or (B) Any company
that would be an investment company under Section 3(a) of the Investment Company Act
but for the exclusion provided from that definition by either Section 3(c)(1), 3(c)(7) or
3(c)(11) of that Act”).
81 See Notice, 80 FR at 81654 n.47 (FINRA notes that, consistent with the SEC Pay-to-Play
Rule, under the proposed rule, if a government entity is an investor in a covered
investment pool at the time a contribution triggering a two-year time-out is made, the
covered member must forgo any compensation related to the assets invested or
committed by the government entity in the covered investment pool) (citing SEC Pay-to-
Play Rule Adopting Release, 75 FR at 41047).
82 See Notice, 80 FR at 81654 n.48 (FINRA states that it added proposed Rule 2030(d)(2) in
response to comments on Regulatory Notice 14-50 to clarify, for purposes of the
proposed rule, the relationship between an investment adviser to a covered investment
pool and a government entity that invests in the covered investment pool).
83 See Notice, 80 FR at 81654 n.49 (citing 17 CFR 275.206(4)-5(c)).
20
would extend the protection of the proposed rule to public pension plans that access the services
of investment advisers through hedge funds and other types of pooled investment vehicles
sponsored or advised by investment advisers as a funding vehicle or investment option in a
government-sponsored plan, such as a 529 plan.84
As noted above, the proposed rule would not apply to distribution activities related to
registered investment companies that are not investment options of a government entity’s plan or
program because in these circumstances a member firm is not providing or seeking to provide
investment advisory services to a government entity.85
The proposed rule would apply to
distribution activities involving unregistered pooled investment vehicles such as hedge funds,
private equity funds, venture capital funds, collective investment trusts, and registered pooled
investment vehicles such as mutual funds, but only if those registered pools are an investment
option of a participant-directed plan or program of a government entity.86
E. Proposed Rule 2030(e): Prohibition on Indirect Contributions or Solicitations
Proposed Rule 2030(e) provides that it shall be a violation of Rule 2030 for any covered
member or any of its covered associates to do anything indirectly that, if done directly, would
result in a violation of the rule.87
FINRA states that this provision is consistent with a similar
provision in the SEC Pay-to-Play Rule88
and would prevent a covered member or its covered
associates from funneling payments through third parties, including, for example, consultants,
84
See Notice, 80 FR at 81654 n.50 (citing SEC Pay-to-Play Rule Adopting Release, 75 FR
at 41044, which discusses the applicability of the SEC Pay-to-Play Rule to covered
investment pools).
85 See Notice, 80 FR at 81661.
86 See id.
87 See Notice, 80 FR at 81654.
88 See id. at n.44 (citing 17 CFR 275.206(4)-5(d)).
21
attorneys, family members, friends, or companies affiliated with the covered member as a means
to circumvent the proposed rule.89
FINRA also notes that, consistent with guidance provided by
the Commission in connection with SEC Pay-to-Play Rule 206(4)-5(d), proposed Rule 2030(e)
requires a showing of intent to circumvent the rule for such persons to trigger the two-year
“time-out.”90
F. Proposed Rule 2030(f): Exemptions
Proposed Rule 2030(f) includes an exemptive provision for covered members, modeled
on the exemptive provision in the SEC Pay-to-Play Rule, that would allow covered members to
apply to FINRA for an exemption from the proposed rule’s two-year “time-out.”91
As proposed,
FINRA states that this provision would allow FINRA to exempt covered members, either
conditionally or unconditionally, from the proposed rule’s time-out requirement where the
covered member discovers contributions that would trigger the compensation ban after they have
been made, and when imposition of the prohibition would be unnecessary to achieve the rule’s
intended purpose.92
In determining whether to grant an exemption, FINRA would take into
account varying facts and circumstances, outlined in the proposed rule, that each application
presents93
(e.g., the timing and amount of the contribution, the nature of the election, and the
89
See Notice, 80 FR at 81654 n.45 (citing SEC Pay-to-Play Rule Adopting Release, 75 FR
at 41044, which discusses direct and indirect contributions or solicitations).
90 See Notice, 80 FR at 81654. See also SEC Pay-to-Play Rule Adopting Release, 75 FR at
41044 n.340 (explaining that like MSRB Rule G-37(d), SEC Pay-to-Play Rule 206(4)-
5(d) “requires a showing of intent to circumvent the rule for such persons to trigger the
time out”) (citing Blount, 61 F.3d at 948 (“In short, according to the SEC, the rule
restricts such gifts and contributions only when they are intended as end-runs around the
direct contribution limitations.”)).
91 See Notice, 80 FR at 81654–55.
92 See id. at 81655.
93 See id.
22
contributor’s apparent intent or motive in making the contribution).94
FINRA notes that this
provision would provide covered members with an additional avenue by which to seek to cure
the consequences of an inadvertent violation by the covered member or its covered associates
that falls outside the limits of one of the proposed rule’s exceptions.95
G. Proposed Rule 4580: Recordkeeping Requirements
Proposed Rule 4580 would require covered members that engage in distribution or
solicitation activities with a government entity on behalf of any investment adviser that provides
or is seeking to provide investment advisory services to such government entity to maintain
books and records that would allow FINRA to examine for compliance with its pay-to-play
rule.96
FINRA states that this provision is consistent with similar recordkeeping requirements
imposed on investment advisers in connection with the SEC Pay-to-Play Rule.97
The proposed
rule also would require covered members to maintain a list or other record of certain specific
information.98
FINRA states that the proposed rule would require, among other things, that the
direct and indirect contributions or payments made by the covered member or any of its covered
associates be listed in chronological order and indicate the name and title of each contributor and
each recipient of the contribution or payment, as well as the amount and date of each
contribution or payment, and whether the contribution was the subject of the exception for
returned contributions in proposed Rule 2030.99
94
See Order Instituting Proceedings, 81 FR at 19263.
95 See Notice, 80 FR at 81655.
96 See id.
97 See id. (citing 17 CFR 275.204-2(a)(18) and (h)(1)).
98 See Notice, 80 FR at 81655–56.
99 See id.
23
III. Summary of Comments and FINRA’s Responses
In response to the Notice, the Commission received ten comment letters, from nine
different commenters.100
Six commenters generally express support for FINRA’s proposal.101
However, five of those commenters, while generally expressing support for the goals of the
proposal, also raise certain concerns regarding various aspects of the proposal as drafted and
recommended amendments to the proposal.102
The other three commenters did not support the
proposed rule as drafted based largely on concerns involving the First Amendment to the U.S.
Constitution.103
FINRA responded, stating that it considered the comments received by the
Commission in response to the Notice, and that FINRA is not intending to make changes to the
proposed rule text in response to the comments.104
The Commission received an additional four comments in response to the Order
Instituting Proceedings.105
On July 6, 2016, FINRA submitted a letter responding to all
comments and to the Order Instituting Proceedings.106
The comments, as well as FINRA’s
100
See supra note 5. CAI submitted two separate comment letters in response to the Notice.
See CAI Letter 1 and CAI Letter 2.
101 See CAI Letter 1; CAI Letter 2; FSI Letter 1; ICI Letter; NAIFA Letter; NASAA Letter;
and PIABA Letter.
102 See CAI Letter 1; CAI Letter 2; FSI Letter 1; NAIFA Letter; NASAA Letter; and PIABA
Letter. ICI did not raise additional concerns, but states that it is satisfied with FINRA’s
revisions and responses to the proposal as drafted in Regulatory Notice 14-50. See ICI
Letter.
103 See CCP Letter 1; Moran Letter; and State Parties Letter 1. Other commenters also raise
certain First Amendment-related concerns. See FSI Letter 1; and CAI Letter 1.
104 See FINRA Response Letter 1.
105 See supra note 10. See also Memorandum from the Division of Trading and Markets
regarding a May 10, 2016 conference call with representatives of CAI; Memorandum
from the Division of Trading and Markets regarding a May 19, 2016 conference call with
representatives of FSI.
106 See supra note 12.
24
responses, are summarized below.107
A. First Amendment Comments and FINRA’s Responses
As noted above, five commenters either oppose the proposed rule108
or raise certain
issues regarding the proposed rule as drafted based largely on First Amendment concerns.109
As
a general matter, these commenters argue that FINRA’s proposed rule is not narrowly tailored to
serve a compelling government interest. While acknowledging that the D.C. Circuit upheld the
constitutionality of a comparable MSRB pay-to-play rule in Blount v. SEC, 61 F.3d 938 (D.C.
Cir. 1995), which also used analogous restrictions to discourage pay-to-play practices, these
commenters believe that Supreme Court precedent has changed since Blount was decided.
In response to these comments, FINRA states that the points raised by the commenters do
not warrant changes to, or disapproval of, its proposed rule change.110
FINRA notes that the
Commission has already reviewed and rejected these arguments in a nearly identical context.111
As FINRA explains, the State Parties filed an unsuccessful lawsuit in 2014 challenging the SEC
107
The comments received in response to the Notice were summarized when the
Commission instituted proceedings. See supra note 9. For further detail, the comments
that the Commission received on both the Notice and the Order Instituting Proceedings
are available on the Commission’s website at http://www.sec.gov/comments/sr-finra-
2015-056/finra2015056.shtml.
108 See CCP Letter 1; and State Parties Letter 1. See also CCP Letter 2; CCP Letter 3; and
State Parties Letter 2.
109 See CAI Letter 1; FSI Letter 1; FSI Letter 2; and Moran Letter.
110 See FINRA Response Letter 2 at 3 (noting that FINRA’s responses to the First
Amendment arguments raised by the State Parties and CCP also address the concerns
raised by CAI, FSI and Moran). A copy of FINRA Response Letter 2 is available at:
https://www.sec.gov/comments/sr-finra-2015-056/finra2015056-18.pdf.
111 See id. (citing N.Y. Republican State Comm. v. SEC, 799 F.3d 1126 (D.C. Cir. 2015)
(affirming dismissal of the petition for lack of subject matter jurisdiction and also
dismissing the petition as time-barred).
25
Pay-to-Play Rule on First Amendment grounds.112
FINRA explains that the State Parties’
comments opposing FINRA’s proposed rule reiterate the arguments advanced in their suit
against the Commission and, although the court of appeals decided the challenge on
jurisdictional grounds, the brief that the Commission filed in the D.C. Circuit is persuasive in
demonstrating that the State Parties’ arguments lack merit.113
FINRA also notes that the SEC
Pay-to-Play Rule, upon which FINRA’s proposed rule change is based, was modeled on pay-to-
play rules that the MSRB drafted, that the Commission approved, and that the D.C. Circuit
upheld against a constitutional challenge in Blount.114
Furthermore, FINRA states that the proposed rule change is justified by a sufficiently
important governmental interest to withstand constitutional scrutiny. For example, FINRA
explains that, as in Blount, the Commission’s interest in preventing fraud and in protecting
market actors from “unfair, corrupt market practices,” are “not only substantial, but . . .
compelling.”115
FINRA also notes that the Commission’s interest in “clean advisory markets is
equally important.”116
FINRA acknowledges the D.C. Circuit’s observation in Blount that “the
link between eliminating pay-to-play practices and the Commission’s goals of ‘perfecting the
mechanism of a free and open market’ and promoting ‘just and equitable principles of trade’ is
self-evident.”117
In addition to noting the important interests served by its proposal, FINRA also
112
See FINRA Response Letter 2 at 3.
113 See id. at 3–4.
114 See id. at 5 (citing Blount, 61 F.3d at 944).
115 See, e.g., FINRA Response Letter 2 at 5 (quoting Blount, 61 F.3d at 944).
116 See, e.g., FINRA Response Letter 2 at 5 (quoting an observation made in Blount that the
Commission’s interest “in clean bond markets” is just as important as a legislature’s
interest “in clean elections”) (quoting Blount, 61 F.3d at 944)).
117 See, e.g., FINRA Response Letter 2 at 5 (quoting Blount, 61 F.3d at 945).
26
notes that, as explained in Blount, the proposed rule change advances this government interest by
seeking to halt an existing pay-to-play problem, even though, in terms of a record, “no smoking
gun is needed;” however, “here, the conflict of interest is apparent, the likelihood of stealth great,
and the [Commission’s] purpose prophylactic.”118
FINRA further believes that the proposed rule change also is “closely drawn” to avoid
unnecessary abridgment of associational freedoms.119
FINRA explains that, like the pay-to-play
rule upheld in Blount, its proposed rule change only “restricts a narrow range of . . . activities for
a relatively short period of time,” and leaves available the “vast majority of political
activities.”120
For example, FINRA notes that the proposal does not attempt to regulate State and
local elections, nor does it impose restrictions on independent expenditures or ban political
contributions, and that each of those significant avenues for political expression remains
unaffected by the proposed rule change.121
FINRA also does not agree with arguments made by
a commenter that FINRA did not consider less restrictive alternatives in drafting its proposal and
that aspects of the proposal are vague or overbroad. FINRA notes that, because the Commission
must find that FINRA’s proposal imposes substantially equivalent or more stringent restrictions
on its member firms as the SEC Pay-to-Play Rule imposes on investment advisers for FINRA
members to be “regulated persons” under the SEC Pay-to-Play Rule, the provisions and
definitions to which the commenter objects are modeled on and substantially similar to
118
See, e.g., FINRA Response Letter 2 at 6 (quoting Blount, 61 F.3d at 945).
119 See, e.g., FINRA Response Letter 2 at 6.
120 See, e.g., id. (quoting Blount, 61 F.3d at 947–48).
121 See, e.g., FINRA Response Letter 2 at 4. See also SEC Pay-to-Play Rule Adopting
Release, 75 FR at 41024 n.71 (explaining that the SEC Pay-to-Play rule “imposes no
restrictions on activities such as making independent expenditures to express support for
candidates, volunteering, making speeches, and other conduct”).
27
provisions in the SEC Pay-to-Play Rule.122
FINRA also states that it will work with the industry
and Commission to address interpretive questions and provide additional guidance, as needed, to
the extent that questions arise regarding the application and scope of the provisions and terms
used in the proposed rule change.123
B. Comments Regarding FINRA’s Authority To Propose a Pay-To-Play Rule and
FINRA’s Responses
Several commenters contend that FINRA does not have the authority to adopt a pay-to-
play rule because only Congress or the Federal Election Commission may regulate contributions
for federal elections.
In response, FINRA states that the proposed rule change is consistent with the authority
Congress granted a registered national securities association like FINRA under Section
15A(b)(6) of the Act to adopt rules that are designed, among other things, to prevent fraudulent
and manipulative acts and practices, to promote just and equitable principles of trade, to perfect
the mechanism of a free and open market and a national market system and, in general, to protect
investors and the public interest.124
FINRA believes that the proposed rule change accomplishes
the goals of Section 15A(b)(6) by, for example, allowing member firms to continue to engage in
distribution or solicitation activities for compensation with governmental entities on behalf of
investment advisers, while at the same time deterring member firms from engaging in pay-to-
play practices.125
FINRA also believes that the proposed rule change is reasonably designed to
122
See, e.g., FINRA Response Letter 2 at 7.
123 See, e.g., id.
124 See id.
125 See id.
28
address the distortion of the investment advisory market and collective action problems created
by pay-to-play practices.126
Although FINRA acknowledges that the proposed rule’s two-year “time-out” provision
might result in fewer covered members and their covered associates making certain political
contributions to certain officials, FINRA notes that if it did not adopt a pay-to-play rule, the SEC
Pay-to-Play Rule would prohibit member firms from soliciting government entities for
investment advisory services for compensation on behalf of investment advisers.127
FINRA
explains that the SEC Pay-to-Play Rule provides that the rules of a self-regulatory organization
(“SRO”), like FINRA, must impose “substantially equivalent or more stringent restrictions” on
its member firms that wish to act as “regulated persons” as the SEC Pay-to-Play Rule imposes on
investment advisers.128
Therefore, unless FINRA imposes sufficiently stringent restrictions,
investment advisers and covered associates will be barred from providing or agreeing to provide,
directly or indirectly, payment to FINRA member firms to solicit a government entity for
investment advisory services on behalf of the investment adviser.129
FINRA believes that the
proposed rule change is a more effective response to the issues addressed in the SEC Pay-to-Play
Rule than a complete ban on solicitation,130
and notes throughout its response that the proposal
126
See id. at 9. As outlined in the SEC Pay-to-Play Adopting Release, pay-to-play activities
create a “collective action” problem in two respects. First, government officials who
participate in such activities may have an incentive to continue to accept contributions to
support their campaigns for fear of being disadvantaged relative to their opponents.
Second, advisers may have an incentive to participate out of concern that they may be
overlooked if they fail to make a contribution. See SEC Pay-to-Play Rule Adopting
Release, 75 FR at 40122.
127 See FINRA Response Letter 2 at 4–5.
128 See id. at 4.
129 See id. See also Notice, 80 FR at 81659.
130 See FINRA Response Letter 2 at 4.
29
imposes substantially equivalent restrictions on FINRA member firms as the SEC Pay-to-Play
Rule imposes on investment advisers.131
C. Variable Annuity-Related Comments and FINRA’s Responses
Two commenters raise concerns regarding the application of the proposed rules to
variable annuities.132
Both of these commenters request, as a threshold matter, that FINRA
confirm that Rule 2030 would not apply to variable annuities.133
One of these commenters
requests that the proposed rule not apply to the sales of variable annuity contracts supported by a
separate account that invests in mutual funds, arguing that the nature of variable annuities and
the way investment options are selected does not implicate the investment advisory solicitation
activities contemplated by the SEC Pay-to-Play Rule.134
This commenter claims that the
relationship between a variable annuity contract holder and the investment adviser to a mutual
fund supporting the variable annuity does not rise to a level such that it should implicate the
proposed pay-to-play rule’s restrictions.135
The other commenter claims, in support of its
argument that Rule 2030 should not apply to variable annuities, that compliance with Rule 2030
would be impractical for broker-dealers selling variable annuities in the government market.136
131
See, e.g., id. at 4, 7.
132 See CAI Letter 1 and FSI Letter 1. See also CAI Letter 2 (reflecting CAI’s suggested
revisions to the certain language in some of FINRA’s proposed rules).
133 See CAI Letter 1 and FSI Letter 1.
134 See FSI Letter 1 (claiming that applying the proposed rule to variable annuities will
significantly increase the compliance burden and as such may limit the options their
members make available to 403(b) and 457 plans).
135 See FSI Letter 1.
136 See CAI Letter 1 (claiming that the dynamics and structure of variable annuities,
particularly those with separate accounts registered as a unit investment trust, and the
number of advisers and sub-advisers to the funds underlying sub-accounts, makes
compliance with proposed Rule 2030 impractical).
30
This commenter also argues, for example, that a covered member selling a variable annuity,
particularly where the separate account is registered as a unit investment trust, cannot fairly be
seen to be engaging in solicitation activities on behalf of all of the investment advisers and sub-
advisers that manage the covered investment pools available as investment options under the
separate account and subaccounts.137
This commenter also requests that proposed Rule 2030 be modified to, among other
things, clarify that the distribution of a two-tiered product such as a variable annuity is not
solicitation activity for an investment adviser and sub-advisers managing the funds available as
investment options.138
Furthermore, this same commenter states that if FINRA or the
Commission determines that broker-dealers selling variable annuities constitute solicitation
activities for purposes of Rule 2030, that determination raises a host of interpretive questions
that, in this commenter’s view, would require further guidance from FINRA or the
Commission.139
In response, FINRA states that its proposed rules must impose substantially equivalent or
more stringent restrictions on member firms as the SEC Pay-to-Play Rule imposes on investment
137
See id.
138 See id.
139 See id. For example, CAI requests guidance on the following questions: Is the selling
broker-dealer deemed to be soliciting on behalf of the adviser of each of the underlying
funds or only of advisers and sub-advisers of funds underlying investment options that
are selected by contract holders? If an underlying fund is managed by an adviser that
uses multiple sub-advisers, is the selling firm deemed to be soliciting on behalf of all of
the sub-advisers? How does the rule apply when a contract holder on his or her own
allocates funds in the variable annuity to an option at a point of time (for example, five
years) subsequent to the purchase of the variable annuity without any involvement of the
selling firm? See id.
31
advisers.140
Therefore, because the Commission did not exclude specific products from the SEC
Pay-to-Play Rule, such as variable annuities, FINRA does not believe that excluding specific
products from its proposed rule would satisfy the Commission’s stringency requirements.141
FINRA notes, however, that to the extent interpretive questions arise regarding the application
and scope of the provisions and terms used in its proposed rules, FINRA will work with the
industry and Commission to address those interpretive questions and provide additional guidance
as needed.142
D. Comments Regarding the Scope of the Proposed Rule and FINRA’s Responses
Two commenters also express concern that proposed Rule 2030(d) would, in their view,
re-characterize “ordinary” or “customary” distribution activities for covered investment pools as
the solicitation of clients on behalf of the investment adviser to the covered investment pools.143
One of these commenters requests that such customary distribution activity by member firms for
covered investment pools sold to government entities not be treated as solicitation activity for an
investment adviser for purposes of Rule 2030 simply because an investment adviser provides
advisory services to a covered investment pool that is available as an investment option.144
As
more fully explained in the commenter’s letter, the commenter claims, for example, that
proposed Rule 2030(d) would recast “traditional” broker-dealer activity (i.e., the offer and sale of
covered investment pool securities pursuant to a selling or placement agent agreement) into
something it is not: the solicitation of investment advisory services on behalf of an investment
140
See FINRA Response Letter 2 at 16.
141 See id.
142 See id.
143 See CAI Letter 1 and FSI Letter 1.
144 See CAI Letter 1.
32
adviser.145
This commenter also claims that the decision in Goldstein v. SEC, 451 F.3d 873
(D.C. Cir. 2006) and the Commission staff’s interpretive position under Advisers Act Rule
206(4)-3 suggest that proposed Rule 2030(d) would be impractical.146
This commenter also
notes that Rule 206(4)-3 puts selling firms in a contradictory position under FINRA rules and
Advisers Act rules.147
This commenter further states that, in its view, a broker-dealer that offers
and sells interests in a mutual fund or private fund cannot be characterized as soliciting on behalf
of the investment adviser to a covered investment pool.148
Similarly, another commenter expresses concern with the apparent application of
proposed Rule 2030(d) to “traditional” brokerage sales of mutual funds and variable annuities to
participant-directed government-sponsored retirement plans.149
As more fully explained in the
commenter’s letter, this commenter continues to be concerned that the provisions in proposed
Rule 2030(d) go beyond that which is required under Rule 206(4)-5(a)(2)(i) and Rule 206(4)-
5(c) to the detriment of investors.150
This same commenter also claims that mutual fund sales, as
well as variable annuity sales, should be excluded, claiming that the proposed rules serve to
redefine the sale of mutual funds as solicitation by a broker-dealer on behalf of an investment
adviser and also conflict with the realities of conventional mutual fund selling agreements.151
145
See id.
146 See id. (claiming that “[i]t would create significant confusion in the industry and
undermine settled practices and understandings, while creating doubt as to the application
of the Goldstein case and the Commission staff’s guidance in the Mayer Brown no-action
letter”).
147 See id.
148 See id.
149 See FSI Letter 1. See also FSI Letter 2
150 See FSI Letter 1. See also FSI Letter 2.
151 See FSI Letter 1. See also FSI Letter 2.
33
In response, FINRA explains that, in proposing FINRA Rule 2030(d), it did not intend to
re-characterize broker-dealers’ selling interests in variable annuities, mutual funds and private
funds as soliciting an investment advisory relationship with investors who invest in those
products.152
Rather, FINRA states that the purpose of proposed Rule 2030(d) is to clarify that
the prohibition of proposed Rule 2030(a) would apply when the covered member is engaging in
distribution or solicitation activities with a government entity on behalf of a covered investment
pool.153
FINRA further explains that proposed Rule 2030(d) is modeled on a similar provision in
the SEC Pay-to-Play Rule, Rule 206(4)-5(c).154
As such, and consistent with SEC Pay-to-Play
Rule 206(4)-5(c), proposed Rule 2030(d) is intended to extend the protections of the proposed
rule to government entities that access the services of investment advisers through hedge funds
and other types of pooled investment vehicles sponsored or advised by investment advisers.155
Finally, FINRA notes that the applicability of proposed Rule 2030(d) is for purposes of FINRA’s
pay-to-play rule only and, as such, would not impact or otherwise affect other FINRA rules or
guidance. Therefore, FINRA has determined not to make the changes suggested by the
commenters.156
152
See FINRA Response Letter 2 at 14.
153 See id.
154 See id.
155 See id. at 15 (noting that when adopting SEC Pay-to-Play Rule 206(4)-5(c), the
Commission stated that although “an investment in a pooled investment vehicle may not
involve a direct advisory relationship with a government sponsored plan [that] does not
change the nature of the fraud or the harm that may be inflicted as a consequence of the
adviser’s pay-to-play activity”) (quoting SEC Pay-to-Play Rule Adopting Release, 75 FR
at 41044–45)).
156 See FINRA Response Letter 2 at 15.
34
E. Comments Regarding the Inclusion of Distribution Activity in the Proposed Rule
and FINRA’s Responses
One commenter generally expresses concern that proposed Rule 2030 is unnecessarily
ambiguous regarding the term “distribution” activities in Rule 2030(a).157
This commenter
claims that it is unclear what distribution activities “with” a government entity would be
prohibited, what compensation is covered by the proposed rule and who must pay it, and when a
member firm might be deemed to be acting “on behalf of” an investment adviser.158
This
commenter states that the ambiguity of proposed Rule 2030 may result in its misapplication in a
variety of contexts, such as: where a selling firm is affiliated with one, but not all, underlying
fund advisers and none of the sub-adviser(s) to any underlying funds, or none of the underlying
fund advisers, but some of the sub-advisers.159
This commenter also claims that, while the SEC Pay-to-Play Rule requires regulated
persons to be subject to rules that prohibit them from engaging in certain distribution activities if
certain political contributions have been made, SEC Pay-to-Play Rule 206(4)-5 does not mandate
the use of the term “distribution” in describing the conduct prohibited by the proposed rule, and
suggested revised rule text reflecting that assertion.160
The commenter believes that its suggested
revisions would eliminate, among other things, the potential concern that a selling firm might
157
See CAI Letter 1.
158 See id.
159 See id.
160 See CAI Letter 1 and CAI Letter 2 (reflecting CAI’s suggested revisions to certain
language in some of FINRA’s proposed rules).
35
violate proposed Rule 2030 unknowingly due to being deemed to be acting on behalf of
investment advisers or sub-advisers of underlying funds with which it has no relationship.161
In response, FINRA states that it continues to maintain the position, outlined in the
Notice, that it will not remove references to the term “distribution.”162
FINRA explains that the
Notice pointed to language in the SEC Pay-to-Play Rule Adopting Release supporting the
inclusion of distribution activities by broker-dealers in FINRA’s proposed Rule 2030.163
Specifically, FINRA pointed to the Commission’s discussion regarding under what
circumstances distribution payments would violate the SEC’s Pay-to-Play Rule.164
FINRA also
notes that based on the Commission’s definition of “regulated person”165
in the SEC’s Pay-to-
Play Rule, as well as the Commission’s discussion regarding the treatment of distribution fees
paid pursuant to a 12b-1 plan as compared to legitimate profits, FINRA believes that its proposed
rule must apply to member firms engaging in distribution activities.166
FINRA mentioned
previously, to the extent that interpretive questions arise regarding the application and scope of
the provisions and terms used in the proposed rule change, FINRA will work with the industry
161
See CAI Letter 1 (claiming that the commenter’s suggested revisions would not result in
any inappropriate narrowing of the scope of Rule 2030).
162 See FINRA Response Letter 2 at 12.
163 See id. at 11–12 (citing Notice, 80 FR at 8166061).
164 See FINRA Response Letter 2 at 12 n.52 (citing SEC Pay-to-Play Rule Adopting
Release, 75 FR at 4104 n.298).
165 See FINRA Response Letter 2 at 12 (explaining that the SEC Pay-to-Play Rule defines a
“regulated person” to include a member firm, provided that FINRA rules prohibit
member firms from engaging in distribution or solicitation activities if political
contributions have been made) (citing 17 CFR 275. 206(4)-5(f)(9)(ii)(A)) (emphasis in
original).
166 See FINRA Response Letter 2 at 12 (citing Notice, 80 FR at 8166061).
36
and Commission to address the interpretive questions and provide additional guidance as
needed.167
F. Comments Regarding Defined Terms Used in the Proposed Rules and FINRA’s
Responses
Two commenters request clarification of certain defined terms used in the proposed
rules.168
One commenter urged FINRA, or the Commission, to clarify the meaning of the term
“instrumentality” as it is used in the definition of “government entity.”169
This commenter
claims that, “[w]ithout additional guidance, covered members will continue to struggle with
whether a contribution to a given entity should be treated as a contribution to an ‘instrumentality’
of a state or state agency, thus triggering the two-year time out. . . .”170
This same commenter
also asked for clarification as to whether each and every “contribution” (as defined in proposed
Rule 2030(g)(1)) is, by definition, also a “payment” (as defined in proposed Rule 2030(g)(9)).171
Another commenter requests that FINRA clarify the definition of a “covered associate”
and clarify and delineate the positions that would qualify someone as a covered “official.”172
This commenter claims that, in response to the same definition of “covered associate” as used in
the SEC Pay-to-Play Rule, many investment advisers and broker-dealers have classified all of
167
See id.
168 See CAI Letter 1 and NAIFA Letter.
169 See CAI Letter 1 (claiming that CAI’s members have struggled to understand the
contours of this term in the context of the SEC Pay-to-Play Rule).
170 See id.
171 See CAI Letter 1 (discussing Notice, 80 FR at 81654 n.41: “Consistent with the SEC
Pay-to-Play Rule, FINRA is including the broader term ‘payments,’ as opposed to
‘contributions,’ to deter a cover member from circumventing the proposed rule’s
prohibitions by coordinating indirect contributions to government officials by making
payments to political parties”).
172 See NAIFA Letter.
37
their representatives as covered associates regardless of whether they actually engage in the
solicitation activity specified in the definition.173
This commenter believes that additional
clarification on when an associated person of a covered member would (or would not) qualify as
a “covered associate” would ease compliance burdens, curtail overly broad limits on legitimate
political activity, and increase the consistency of procedures amongst member firms who seek to
comply with both the letter and the spirit of the proposed rule.174
This same commenter requests
additional details or guidance from the Commission with respect to this definition of “official”
because, according to that commenter, that definition has caused, and will continue to spark
confusion over exactly what offices subject the holder to be classified as an “official” given that
the term is defined the same way in the SEC Pay-to-Play Rule.175
In response, FINRA states that it recognizes, as did the commenters, that these terms are
defined in the SEC Pay-to-Play Rule and that FINRA modeled the definitions in its proposal on
those in the SEC Pay-to-Play Rule.176
With respect to CAI’s request for clarification as to
whether each and every “contribution” (as defined in proposed FINRA Rule 2030(g)(1)) is, by
definition, also a “payment” (as defined in proposed FINRA Rule 2030(g)(9)), FINRA states that
the definition of “payment” is similar to the definition of “contribution,” but is broader because it
does not include limitations on the purposes for which such money is given (e.g., it does not have
to be made for the purpose of influencing an election).177
Finally, FINRA also acknowledges the
concerns raised by the commenters and the requests for clarification and additional guidance
173
See id.
174 See id.
175 See id.
176 See FINRA Response Letter 2 at 18.
177 See id. at 17.
38
from the Commission and FINRA as to certain terms.178
FINRA again states that to the extent
that interpretive questions arise regarding the application and scope of the provisions and terms
used in the proposed rule change, FINRA will work with the industry and Commission to
address the interpretive questions and provide additional guidance as needed.179
G. Comments Regarding PAC Contributions and FINRA’s Responses
One commenter claims that statements made by FINRA in the Notice regarding the
proposed rule’s anti-circumvention provision, proposed Rule 2030(e), combined with statements
made in Commission staff guidance concerning whether contributions through PACs would
violate the SEC Pay-to-Play Rule and Section 208(d) of the Advisers Act, have the ability to
chill contributions to PACs.180
This commenter claims, for example, that prospective
contributors who simply want to donate to a PAC have been hesitant to or restricted from doing
so out of fear that they may be making an indirect contribution in violation of the SEC Pay-to-
Play Rule.181
Accordingly, this commenter requests further guidance from the Commission on
the factors by which contributions to PACs would or would not trigger the anti-circumvention
provision of the proposed rule.182
In response, FINRA again acknowledges the concerns raised by the commenter and the
requests for clarification and additional guidance from the Commission and FINRA.183
FINRA
states that, to the extent that interpretive questions arise regarding the application and scope of
178
See id. at 19.
179 See id.
180 See NAIFA Letter.
181 See id.
182 See id.
183 See FINRA Response Letter 2 at 19.
39
the provisions and terms used in the proposed rule change, FINRA will work with the industry
and Commission to address the interpretive questions and provide additional guidance as
needed.184
Another commenter claims that it continues to believe that not all payments to political
parties or PACs should have to be maintained under the books and records requirements of
proposed Rule 4580.185
Rather, this commenter believes that only payments to political parties
or PACs where the covered member or a covered associate: (i) directs the political party or PAC
to make a contribution to an official of a government entity which the covered member is
soliciting on behalf of an investment adviser; or (ii) knows that the political party or PAC is
going to make a contribution to an official of a government entity which the covered member is
soliciting on behalf of an investment adviser, should have to be maintained.186
This commenter
states that, while it appreciates FINRA’s rationale for proposed Rule 4580, it believes the costs
and burdens associated with the request far outweigh the benefits to FINRA in ensuring
compliance with the rule and would lead to periodic “fishing expeditions” by FINRA
examiners.187
In response, FINRA states that it disagrees with these comments and has determined to
retain the recordkeeping requirements as proposed in FINRA Rule 4580.188
FINRA notes that,
as discussed in the Notice, payments to political parties or PACs can be a means for a covered
member or covered associate to funnel contributions to a government official without directly
184
See id. at 18.
185 See CAI Letter 1.
186 See id.
187 See id.
188 See FINRA Response Letter 2 at 20.
40
contributing.189
Therefore, FINRA states that it is proposing to require a covered member to
maintain a record of all payments to political parties or PACs as such records would assist
FINRA in identifying situations that might suggest an intent to circumvent the rule.190
H. Comments Regarding the De Minimis Exception under Proposed Rule 2030(c)
and FINRA’s Responses
As discussed above, certain commenters raise concerns regarding the exception for de
minimis contributions under proposed Rule 2030(c)(1) on First Amendment grounds.191
In
addition, one commenter requests that the $350 and $150 amounts “be raised substantially” in
both the SEC Pay-to-Play Rule and in proposed Rule 2030(c)(1), and further requests that the
$350 limitation on the proposed exception for returned contributions under proposed Rule
2030(c)(3) be eliminated in both the SEC Pay-to-Play Rule and in FINRA’s proposed rule.192
In response, FINRA explains that its proposed rules must impose substantially equivalent
or more stringent restrictions on member firms as the SEC Pay-to-Play Rule imposes on
189
See id. As FINRA explains in the Notice, a covered associate would include a PAC
controlled by the covered member or any of its associates. FINRA states that it would
consider a covered member or its covered associates to have “control” over a PAC if the
covered member or covered associate has the ability to direct or cause the direction of
governance or operations of the PAC. See Notice, 80 FR at 81653, 81660 (noting that
this position is consistent with the position taken by the SEC in connection with the SEC
Pay-to-Play Rule) (citing SEC Pay-to-Play Adopting Release, 75 FR at 41032).
190 See FINRA Response Letter 2 at 20–21. FINRA states in the Notice that the proposed
recordkeeping requirements are intended to allow FINRA to examine for compliance
with its proposed pay-to-play rule, and the reference to indirect contributions in proposed
Rule 4580(a)(4) is intended to include records of contributions or payments a covered
member solicits or coordinates another person or PAC to make under proposed Rule
2030(b). See Notice, 80 FR at 81663.
191 For a discussion of these First Amendment comments and FINRA’s responses, see
Section III.A, supra.
192 See CAI Letter 1 (claiming that these contribution amounts fail to take inflation into
consideration and are “unreasonably low”).
41
investment advisers.193
Therefore, FINRA has proposed exceptions for de minimis contributions
and returned contributions that are consistent with similar exceptions in the SEC Pay-to-Play
Rule.194
FINRA does not believe that raising the limits for the de minimis exception or
eliminating the limit for returned contributions would impose substantially equivalent or more
stringent restrictions on member firms as the SEC Pay-to-Play Rule imposes on investment
advisers.195
I. Comments Regarding the Grandfathering of Existing Accounts and Contracts and
FINRA’s Responses
One commenter requests that FINRA clarify the application of the proposed rule to
existing government entity accounts or contracts.196
FSI requests that, in the event that FINRA
does not amend the application of its proposed rule to covered investment pools (as requested by
this same commenter), FINRA apply the proposed rule only to accounts and variable contracts
opened after the effective date.197
In response, FINRA explains that, as discussed above, its proposed rules must impose
substantially equivalent or more stringent restrictions on member firms as the SEC Pay-to-Play
Rule imposes on investment advisers.198
The Commission did not apply its rule only to contracts
or accounts opened after the effective date of the rule.199
FINRA also explains in the Notice that,
if the Commission approves the proposed rule change, proposed Rule 2030(a) will not be
193
See FINRA Response Letter 2 at 19.
194 See id.
195 See id.
196 See FSI Letter 1.
197 See id.
198 See FINRA Response Letter 2 at 16.
199 See id. See also Notice, 80 FR at 81656.
42
triggered by contributions made prior to the rule’s effective date, and that the rule will not apply
to contributions made prior to the effective date by new covered associates to which the two
years or, as applicable, six months ‘‘look back’’ applies.200
FINRA states that the transition
period—the time between the Commission approving the proposal and FINRA announcing the
effective date of the rule—will provide member firms with time to identify their covered
associates and government entity clients and to modify their supervisory systems to address new
obligations under the rules.201
Therefore, FINRA does not believe that limiting the application of
its rule in the way suggested by FSI would impose substantially equivalent or more stringent
restrictions on member firms as the SEC Pay-to-Play Rule imposes on investment advisers.202
J. Comments Regarding Application of the Proposed Rules to the Independent
Business Model and FINRA’s Responses
One commenter claims that its members “will face difficulties” in attempting to comply
with the proposed rules, and that these difficulties stem, primarily, from a requirement for
independent firms to implement a rule that is premised on the notion that solicitation of clients is
performed pursuant to a centralized process controlled by the management of a registered
investment adviser.203
This same commenter claims that the “lack of clarity” as to the
application of the SEC Pay-to-Play Rule to its members’ independent business model, and the
200
See Notice, 80 FR at 81656.
201 See id. (“FINRA intends to establish an effective date that is no sooner than 180 days
following publication of the Regulatory Notice announcing Commission approval of the
proposed rule change, and no later than 365 days following Commission approval of the
proposed rule change.”).
202 See FINRA Response Letter 2 at 16.
203 See FSI Letter 1 (claiming FSI believes that the SEC Pay-to-Play Rule has inadvertently
captured non-corrupting activity and fears that the proposed rule may do the same).
43
scope of government officials that trigger the requirements, has led some firms to adopt
aggressive compliance programs that prohibit political contributions.204
In response, FINRA states that, consistent with the SEC Pay-to-Play Rule, it has
determined not to except from its proposed pay-to-play rule member firms engaged in the
independent business model.205
FINRA, however, states that, to the extent that interpretive
questions arise regarding the application and scope of the provisions and terms used in the
proposed rule change, FINRA will work with the industry and Commission to address the
interpretive questions and provide additional guidance as needed.206
K. Comments Requesting More Stringent Requirements in the Proposed Rules and
FINRA’s Responses
Two commenters suggested that proposed Rule 2030 include more stringent requirements
in certain respects.207
First, both commenters request that FINRA expand the applicability of its
proposed rules to include state-registered investment advisers.208
More specifically, one of these
commenters suggests that FINRA include state-registered investment advisers in its definition of
“investment adviser” for the purposes of its proposed rule.209
Although FINRA states in the
Notice that relatively few state-registered investment advisers manage public pension plans,210
204
See id. (claiming that, absent clarity concerning the application of the proposed rule to
the brokerage services provided to 403(b) and 457 plans, FSI’s members will be faced
with the choice of either adopting similarly aggressive policies or prohibiting sales to
government-sponsored retirement plans).
205 See FINRA Response Letter 2 at 18.
206 See id.
207 See NASAA Letter and PIABA Letter.
208 See NASAA Letter and PIABA Letter.
209 See NASAA Letter.
210 See NASAA Letter and PIABA Letter.
44
one commenter believes that this alone does not justify permitting FINRA-member firms that do
manage public pension plans, but happen to work with smaller investment advisers, to engage in
pay-to-play activities with no repercussions.211
Another commenter claims that state-registered
investment advisers now include larger firms and, therefore, it is much more likely that state-
registered investment advisers will manage or advise public pension plans or similar funds.212
In response, FINRA states that, as discussed in the Notice,213
to remain consistent with
the SEC Pay-to-Play Rule, FINRA has determined not to expand the scope of the proposed rule
as suggested by commenters to include state-registered investment advisers in its definition of
“investment adviser” for the purposes of its proposed rule.214
As discussed in the Notice, FINRA
explains that the Commission also declined to make a similar change to its proposed rule, stating
that it was the Commission’s understanding that few of these smaller firms manage public
pension plans or other similar funds.215
Second, these two commenters request that FINRA include a mandatory disgorgement
provision for violations of its proposed rule.216
These commenters state that they are
disappointed that FINRA removed the mandatory disgorgement provisions from the proposal as
211
See PIABA Letter. Unless the commenter is discussing dually-registered intermediaries,
we do not understand the commenter’s reference to “FINRA-member firms that do
manage public pension plans” as those plans are managed by investment advisers, not
broker-dealers.
212 See NASAA Letter.
213 See Notice, 80 FR at 81652 n.26 (explaining that “consistent with the SEC Pay-to-Play
Rule, the proposed rule would not apply to state-registered investment advisers as few of
these smaller firms manage public pension plans or other similar funds”). See also id. at
81660 n.98 (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at 41026).
214 See FINRA Response Letter 2 at 10.
215 See Notice, 80 FR at 81652 n.26. See also id. at 81660 n.98.
216 See NASAA Letter and PIABA Letter.
45
outlined in FINRA’s Regulatory Notice 14-50.217
These commenters believe that a mandatory
disgorgement provision would act as a significant deterrent to engaging in pay-to-play schemes,
and it should remain in FINRA’s final rule.218
In response, FINRA states that, after considering similar comments made in response to
its Regulatory Notice 14-50, in particular, that FINRA has authority to require disgorgement of
fees in enforcement actions, FINRA determined not to include a disgorgement requirement in its
proposal.219
For those same reasons, which also are discussed in the Notice,220
FINRA also has
determined not to revise the proposal to include a disgorgement requirement.221
Finally, one commenter believes that the cooling-off period in the proposal should be at
least four years.222
PIABA believes that the two-year cooling-off period does not adequately
reduce the incentive for FINRA member firms to make political contributions to obtain pay-to-
play advantages.223
PIABA states FINRA should start with the most comprehensive rule, and
that it would welcome the deterrent effect of a four-year cooling off period.224
217
See NASAA Letter and PIABA Letter.
218 See NASAA Letter and PIABA Letter.
219 See FINRA Response Letter 2 at 19–20.
220 See Notice, 80 FR at 81662 (noting, for example, ICI’s comment made in connection
with Regulatory Notice 14-50 that “including disgorgement as a penalty is not necessary
given that the SEC and FINRA both have full authority to require disgorgement of fees,
and indeed, disgorgement has been the penalty universally applied (along with additional
penalties) in enforcement actions under existing pay-to-play rules, such as MSRB Rule
G-37 and SEC Rule 206(4)-5”).
221 See FINRA Response Letter 2 at 20.
222 See PIABA Letter.
223 See id.
224 See id.
46
FINRA declines to make PIABA’s suggested change.225
FINRA explains that the
proposed two-year time-out is consistent with the time-out period in the SEC’s Pay-to-Play Rule
and, FINRA believes that a two-year time-out period from the date of a contribution is sufficient
to discourage covered members from engaging in pay-to-play practices.226
As FINRA explains
in the Notice, the two-year time-out in the proposed rule is intended to discourage covered
members from participating in pay-to-play practices by requiring a cooling-off period during
which the effects of a quid pro quo political contribution on the selection process can be
expected to dissipate.227
IV. Discussion and Commission Findings
After carefully considering the proposed rule change, the comments submitted, and
FINRA’s responses thereto, the Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations thereunder applicable to a
registered national securities association.228
225
See FINRA Response Letter 2 at 10.
226 See id.
227 See Notice, 80 FR at 81651. As the Commission explained, the two-year “cooling-off
period’” is not a penalty but, rather, is intended to be a period during which any effects of
a quid pro quo are expected to dissipate. See SEC Pay-to-Play Adopting Release, 75 FR
at 41026 n.104.
228 In approving this proposed rule change, the Commission has considered the proposed
rule change’s impact on efficiency, competition, and capital formation. In this regard, the
Commission considered FINRA’s extensive discussion of these effects in its Notice and
FINRA’s response to comments on that discussion. Moreover, the Commission observes
that, in response to the Commission’s Notice, no commenter suggested that FINRA’s
analysis was incorrect or incomplete, or that the proposed rule change would have a
negative effect on efficiency, competition, or capital formation. See 15 U.S.C. 78c(f).
47
In particular, the Commission finds that the proposed rule change is consistent with
Section 15A(b)(6) of the Act.229
Section 15A(b)(6), which governs registered national securities
associations like FINRA, requires, among other things, that the association’s rules be “designed
to prevent fraudulent and manipulative acts and practices, to promote just and equitable
principles of trade, . . . to remove impediments to and perfect the mechanism of a free and open
market and a national market system and, in general, to protect investors and the public
interest.”230
As discussed in more detail below, we believe that FINRA’s proposal is consistent
with Section 15A(b)(6). FINRA’s proposed rule will address the regulatory concerns that
underlie, and thus support the objectives of, the SEC Pay-to-Play Rule, discussed below, by
discouraging FINRA member firms and certain of their covered associates from engaging in quid
pro quo corruption that may create market distortions—when, for example, an investment
adviser is chosen on the basis of a placement agent’s political contributions rather than the
adviser’s merit. Such conduct impedes a free and open market, and may harm investors and the
public interest if government entities, including public pension plans, and their beneficiaries
receive inferior services or pay higher fees.231
FINRA’s proposed rule also promotes a free and
open market and the protection of investors and the public interest by avoiding the outright ban
on distribution and solicitation activity that would result if FINRA member firms were not
“regulated person[s]” under the SEC Pay-to-Play Rule.232
The fact that FINRA’s proposed rule
229
15 U.S.C. 78o-3(b)(6).
230 Id.
231 See FINRA Response Letter 2 at 8. See also Notice, 80 FR at 81651, 81656 (discussing
the regulatory objectives of and statutory basis for the proposal).
232 See FINRA Response Letter 2 at 5 (“FINRA believes that the proposed rule change is a
more effective response to the issues addressed in the SEC Pay-to-Play Rule than a
48
may have implications for a small subset of political contributions made by certain covered
associates to certain elected officials does not somehow eliminate FINRA’s ability to adopt rules
pursuant to the Act, or the Commission’s authority to approve such rules under Section 19(b)(2)
of the Act.233
As support for the need for the proposed rule, FINRA outlined certain regulatory
concerns in the Notice that also were identified by the Commission in connection with its
adoption of the SEC Pay-to-Play Rule.234
These concerns, which also implicate the investor and
public interest protections described in Section 15A(b)(6) of the Act, recognize the central role
intermediaries, such as “solicitors” or “placement agents,” have played in actions that the
Commission and other authorities have brought involving pay-to-play schemes.235
FINRA also
acknowledges the Commission’s observation of how investment advisers, in several instances,
allegedly made significant payments to placement agents and other intermediaries to influence
complete ban on solicitation.”). See also Notice, 80 FR at 81652, 81656 (discussing the
regulatory objectives of and statutory basis for the proposal).
233 While FINRA’s proposed rule does not bar member firms and their covered associates
from making contributions, it may affect the propensity of member firms and certain
employees to make the subset of contributions that would trigger the two-year time-out.
FINRA’s rule does not impose a requirement that member firms publicly disclose
political contributions.
234 See Notice, 80 FR at 81651, nn.12–14 (discussing concerns the Commission identified in
the SEC Pay-to-Play Rule Adopting Release, 75 FR at 41037).
235 See Notice, 80 FR at 81651. See also id. at nn.10–11 (explaining that “solicitors”
typically locate investment advisory clients on behalf of an investment adviser, and that
“placement agents” typically specialize in finding investors, often institutional investors
or high net worth investors, that are willing and able to invest in a private offering of
securities on behalf of the issuer of such privately offered securities) (citing Advisers Act
Release No. 2910 (Aug. 3, 2009), 74 FR 39840, 39853 n.137 (Aug. 7, 2009) (Political
Contributions by Certain Investment Advisers)).
49
the award of advisory contracts.236
Moreover, FINRA points out the difficulties that investment
advisers face in monitoring or controlling the activities of their third-party solicitors.237
As we explained in adopting the SEC Pay-to-Play Rule, public pension plans are
particularly vulnerable to pay-to-play practices, and we have been particularly concerned that the
engagement of placement agents who have made political contributions to key officials is viewed
by investment advisers as a necessary step to securing a contract with a public pension plan.238
In connection with the SEC Pay-to-Play Rule, we initially proposed a complete bar on
investment advisers engaging third parties to solicit government clients on their behalf because
of concerns about investment advisers’ use of third-party solicitors and placement agents to
engage in pay-to-play activities.239
However, persuaded by commenters, we revised the
proposed SEC Pay-to-Play Rule to permit advisers to make payments to certain “regulated
persons” to solicit government clients on their behalf, provided that they are themselves subject
to prohibitions against participating in pay-to-play practices, are subject to Commission
oversight and, in the case of broker-dealers, the oversight of a registered national securities
236
See Notice, 80 FR at 81651. See also e.g., SEC Pay-to-Play Adopting Release, 75 FR at
41037.
237 See Notice, 80 FR at 81651. See also SEC Pay-to-Play Adopting Release, 75 FR at
41032 n.182, 40137 n.266 (acknowledging commenters’ concerns regarding the
difficulties that advisers may have when monitoring the activities of their third-party
solicitors).
238 See SEC Pay-to-Play Adopting Release, 75 FR at 41019–20, nn.16–25 (collecting
examples of SEC litigation releases as well as state and federal criminal actions with pay-
to-play schemes involving placement agents among other intermediaries). See also id. at
40137, n.262 (collecting examples of state and local legislative actions undertaken to
prohibit or regulate pay-to-play practices involving placement agents in response to
concerns about pay-to-play activities in their jurisdictions).
239 See id. at 41037 nn.259–68 (discussing the Commission’s observations in the SEC Pay-
to-Play Rule proposing release).
50
association such as FINRA.240
FINRA agreed and informed us that it would prepare rules for
our consideration that would prohibit its members from soliciting advisory business from a
government entity on behalf of an adviser unless they comply with pay-to-play restrictions.241
Pay-to-play practices are harmful. They create an impediment to a free and open market
by, for example, distorting the investment adviser selection process from one that is based on
merit, performance and cost, to one that is influenced by a placement agent’s contributions to the
campaigns of government officials who are responsible for, or can influence the outcome of,
selecting an investment adviser.242
As a result of this distortion, government entities, including
pension funds, and their citizen beneficiaries may be harmed by receiving inferior services or
paying higher fees.243
Investors and the public interest ultimately suffer, including taxpayers,
residents who rely on municipal services, and the beneficiaries of public pension funds, such as
firemen, police officers, teachers, and other civil servants.244
Investment advisers also are
240
See id. at 41041.
241 See Notice, 80 FR at 81651 n.15 (citing a letter from Richard G. Ketchum, Chairman and
Chief Executive Officer, FINRA, to Andrew J. Donohue, Director, Division of
Investment Management, Commission (Mar. 15, 2010) (“Ketchum Letter”), available at
http://www.sec.gov/comments/s7-18-09/s71809-260.pdf (stating that FINRA “believe[s]
that a regulatory scheme targeting improper pay to play practices by broker-dealers acting
on behalf of investment advisers is . . . a viable solution to a ban on certain private
placement agents serving a legitimate function”)). FINRA also notes that in developing
its proposal it intended to draw closely upon all the substantive and technical elements of
the Commission’s rule as well as FINRA’s regulatory expertise in examining and
enforcing the MSRB rules, upon which the SEC Pay-to-Play Rule is based. See Ketchum
Letter. See also SEC Pay-to-Play Adopting Release, 75 FR at 41042 n.317 (discussing
same).
242 See, e.g., SEC Pay-to-Play Adopting Release, 75 FR at 41023, 41039.
243 SEC Pay-to-Play Adopting Release, 75 FR at 41019.
244 SEC Pay-to-Play Adopting Release, 75 FR at 41019 (noting that the management of
public pension plans “most significantly . . . affects taxpayers and the beneficiaries of
these funds, including the millions of present and future State and municipal retirees who
rely on the funds for their pensions and other benefits”).
51
harmed because their ability to participate in the market is impeded unless they are willing to
engage in pay-to-play practices by, for example, hiring placement agents that make certain
political contributions.245
The Commission also believes that the stealth in which pay-to-play practices occur and
the inability of markets to properly address these practices argue strongly for rules like the SEC
Pay-to-Play Rule and FINRA’s proposal.246
Pay-to-play practices create a “collective action”
problem in two respects: (1) government officials who participate in such activities have an
incentive to continue to accept contributions to support their campaigns for fear of being
disadvantaged relative to their opponents; and (2) investment advisers have an incentive to
participate out of concern that they may be overlooked if they fail to make a contribution.247
We believe that application of FINRA’s proposed pay-to-play rules will effectively
discourage covered members and their covered associates who act as placement agents for
investment advisers from participating in pay-to-play practices because their political
contributions or payments will be subject to restrictions similar to those imposed on investment
advisers under the SEC Pay-to-Play Rule.248
The Commission therefore believes that FINRA’s
proposed rule change will help address the concerns identified in the SEC Pay-to-Play Rule
245
See, e.g., SEC Pay-to-Play Adopting Release, 75 FR at 41023, 41039 (explaining that
“pay to play practices may hurt smaller advisers that cannot afford the required
contributions. Curtailing pay to play arrangements enables advisory firms, particularly
smaller advisory firms, to compete on merit, rather than their ability or willingness to
make contributions”).
246 See SEC Pay-to-Play Adopting Release, 75 FR at 40122–23. See also FINRA Response
Letter at 6 (noting that, as explained in Blount, “no smoking gun is needed;” however,
“where, as here, the conflict of interest is apparent, the likelihood of stealth great, and the
[Commission’s] purpose prophylactic”).
247 See FINRA Response Letter at 9; SEC Pay-to-Play Adopting Release, 75 FR at 40122.
248 See Notice, 80 FR at 81651.
52
Adopting Release regarding the distortion of the investment advisory market.249
As a result, like
the SEC Pay-to-Play rule, FINRA’s proposal should help protect investors and the public interest
by, among other things, reducing the costs to plans and their beneficiaries of inferior asset
management services arising from adviser selection based on a placement agent’s political
contributions rather than prudential investment considerations.250
Further, in the Commission’s
view, FINRA’s proposed rule strikes an appropriate balance in addressing these regulatory
concerns by providing for FINRA member firms to be “regulated person[s]” under the SEC Pay-
to-Play Rule.251
As a result, investment advisers will be able to continue to benefit from the use
of placement agents in obtaining investment advisory business with government entities without
political contributions distorting the process by which a government entity, such as a public
pension fund, selects an adviser.252
The two-year time-out period imposed by the proposed rule
change is not a penalty but, rather, is intended to discourage participation in pay-to-play practices
by requiring a “cooling-off period” during which the effects of a quid pro quo political
249
See FINRA Response Letter at 9 (stating that “[f]or example, the proposed rule change is
reasonably designed to address the distortion of the investment advisory market and
collective action problems created by pay-to-play practices”). As the Commission has
explained, by addressing distortions in the process by which investment advisers are
selected regarding public investments, pay-to-play rules provide important protections to
public pension plans and their beneficiaries, as well as participants in other important
plans or programs sponsored by government entities. See SEC Pay-to-Play Adopting
Release, 75 FR at 41023, 41054.
250 See SEC Pay-to-Play Adopting Release, 75 FR at 41039.
251 See, e.g., FINRA Response Letter at 5 (“FINRA believes that the proposed rule change is
a more effective response to the issues addressed in the SEC Pay-to-Play Rule than a
complete ban on solicitation.”) See also Notice, 80 FR at 81652, 81656 (discussing the
regulatory objectives of and statutory basis for the proposal).
252 See, e.g., FINRA Response Letter 2 at 8 (“The proposed rule change accomplishes these
goals by allowing member firms to continue to engage in distribution or solicitation
activities for compensation with governmental entities on behalf of investment advisers,
while at the same time deterring member firms from engaging in pay-to-play practices.”).
53
contribution on the selection process are expected to dissipate.253
This time-out will help
promote fair competition in the market and protect public pension funds and investors by curbing
fraudulent conduct resulting from pay-to-play practices.254
In addition, according to FINRA, the
proposal can be expected to help promote competition by allowing more third-party solicitors to
participate in the market for solicitation services, which in turn may reduce costs to investment
advisers and improve competition for advisory services.255
For these reasons and as discussed
throughout, the Commission finds that the proposed rule change is consistent with Section
15A(b)(6) of the Act.256
The Commission notes that most commenters to the Notice257
and some of the
commenters responding to the Order Instituting Proceedings258
generally express support for
FINRA’s proposal. For example, one commenter states that it is pleased that, like the SEC and
the MSRB, FINRA is adopting rules to govern the activities of its members that solicit
government clients on behalf of an investment adviser and also is pleased that FINRA’s proposal
is designed to complement, and be consistent with, the SEC’s pay-to-play rule.259
Similarly,
another commenter states that, although it requests certain revisions, it also supports FINRA’s
253
See Notice, 80 FR at 81651. See also SEC Pay-to-Play Adopting Release, 75 FR at
41026 n.104.
254 See Notice, 80 FR at 81657.
255 See id.
256 See 15 U.S.C. 78o-3(b)(6).
257 See CAI Letter 1; CAI Letter 2; FSI Letter 1; ICI Letter; NAIFA Letter; NASAA Letter;
and PIABA Letter.
258 See FSI Letter 2 (claiming that the proposal creates “compliance uncertainties” for FSI’s
members, but noting that FSI “support[s] regulatory efforts to combat pay-to-play
corruption activity”).
259 See ICI Letter.
54
attempt to deter pay-to-play activity among covered members and supports the regulatory
objectives underlying the Proposed Rules.260
The Commission acknowledges the concerns and questions raised by some commenters,
which are outlined in further detail above in Section III. As discussed below, the Commission
believes, however, that FINRA has responded to the commenters’ concerns and questions in
light of, among other things, the regulatory framework established by the SEC Pay-to-Play Rule,
which provides that FINRA’s proposed rules must impose substantially equivalent or more
stringent restrictions on its members than the SEC Pay-to-Play Rule imposes on investment
advisers for FINRA members to be “regulated persons” under the SEC Pay-to-Play Rule.
A. Comments Concerning the First Amendment and Related Concerns
Several commenters express the view that FINRA’s proposed rule violates the First
Amendment.261
The Commission is sensitive to the constitutional concerns raised by the
commenters, but after careful consideration of their arguments, for the reasons discussed below,
concludes that FINRA’s rule is consistent with the First Amendment.
FINRA’s rule, which focuses on covered members who serve as placement agents, tracks
the SEC Pay-to-Play Rule for investment advisers, which, in turn, tracks the MSRB’s pay-to-
play rule, Rule G-37, which the D.C. Circuit upheld against First Amendment challenge in
1995.262
The Supreme Court has issued several decisions regarding political speech since Blount
260
See CAI Letter 1 (recognizing “the challenges in crafting the Proposed Rules so that they
reach all of the activity sought to be eliminated without also prohibiting activity that is
harmless”).
261 See CCP Letter 1; FSI Letter 1; FSI Letter 2; and State Parties Letter 1. See also CCP
Letter 2; CCP Letter 3; Moran Letter and State Parties Letter 2.
262
Blount v. SEC, 61 F.3d 938 (D.C. Cir. 1995), cert. denied, 517 U.S. 1119 (1996). One
significant difference between the MSRB rule, on one hand, and the SEC’s and FINRA’s
55
was decided,263
and none of these decisions call into question Blount’s holding that a tailored
pay-to-play rule, which is nearly identical in purpose and form to FINRA’s proposed rule and
which also furthers an important public interest, is constitutional. Indeed, the en banc D.C.
Circuit recently and unanimously upheld a broader pay-to-play restriction—a bar on all
contributions to federal candidates by federal contractors—in its decision in Wagner that
analyzed the post-Blount Supreme Court decisions and cited Blount with approval.264
Various
pay-to-play restrictions imposed by other jurisdictions also have withstood First Amendment
challenge in recent years.265
Decisions like Wagner confirm that even an outright limitation on contributions—as
opposed to FINRA’s rule, which may indirectly discourage contributions—is permissible if it is
justified by a sufficiently important government interest and is closely drawn to avoid
unnecessary abridgement of the type of political speech represented by a political contribution.266
rules, on the other, is that the MSRB rule requires the public disclosure of political
contributions whereas the SEC’s and FINRA’s rules do not.
263 See, e.g., McCutcheon v. FEC, 134 S. Ct. 1434 (2014); Citizens United v. FEC, 558 U.S.
310 (2010); Davis v. FEC, 554 U.S. 724 (2008); FEC v. Wisc. Right To Life, Inc., 51
U.S. 449 (2007); Randall v. Sorrell, 548 U.S. 230 (2006); FEC v. Beaumont, 539 U.S.
146 (2003); Nixon v. Shrink Mo. Gov’t PAC, 528 U.S. 377 (2000).
264 Wagner v. FEC, 793 F.3d 1 (D.C. Cir. 2015) (en banc), cert. denied sub nom., Miller v.
FEC, 136 S. Ct. 895 (2016).
265 See, e.g., Yamada v. Snipes, 786 F.3d 1182 (9th Cir.), cert. denied, 136 S. Ct. 569
(2015); Preston v. Leake, 660 F.3d 726, 729–30, 736 (4th Cir. 2011); Ognibene v. Parkes,
671 F.3d 174, 179–80 (2d Cir. 2011); Green Party of Connecticut v. Garfield, 616 F.3d
189, 200 (2d Cir. 2010).
266 Wagner, 793 F.3d at 6–8. We note that FINRA’s rule is not an absolute bar on
contributions, but the two-year time-out may have the effect of discouraging member
firms and certain covered associates who may act as placement agents for investment
advisers from making certain contributions to certain covered officials. To the extent that
the commenters suggest that such an indirect limitation on contributions would be
reviewed by a court under strict scrutiny, they misstate applicable Supreme Court
precedent, which has maintained that limitations on contributions are reviewed under a
56
We believe that FINRA’s proposed rule serves a vitally important governmental interest:
discouraging a specific type of quid pro quo corruption in which political contributions made by
placement agents may influence the award of investment advisory business by government
entities. The Supreme Court has long held that halting quid pro quo corruption is an important
government interest that justifies limitations—or outright bans—on contributions.267
We do not understand FINRA to be engaging in broad electoral reform or trying to clean
up the electoral process. Rather, to avoid the outright ban on placement agent activity resulting
from FINRA member firms not being “regulated person[s]” under the SEC Pay-to-Play Rule, the
two-year time-out in FINRA’s proposal, like the SEC Pay-to-Play Rule, discourages quid pro
quos that affect government entities, including public pension funds, served by investment
advisers. Quid pro quos involving placement agents, who make contributions to certain elected
officials and then assist investment advisers in obtaining business from the government entities
those officials serve may be: fraudulent, run counter to just and equitable principles of trade,
impede a free and open market, and harm investors and the public interest.268
When pay-to-play
is a factor in the selection or retention of an investment adviser—when the adviser is chosen on
the basis of a placement agent’s political contributions rather than its merit—the most qualified
adviser may not be hired, which may lead to inferior performance and payment of higher fees.269
Ultimately, taxpayers and fund beneficiaries suffer the harm. Moreover, pay-to-play distorts free
more intermediate form of scrutiny because “[c]ontribution limits impose a lesser
restraint on political speech” that permits “‘symbolic expression of support evidence by a
contribution” but do not “‘in any way infringe the contributor’s freedom to discuss
candidates and issues.’” McCutcheon, 134 S. Ct. at 1444, quoting Buckley v. Valeo, 424
U.S. 1, 21 (1976).
267 McCutcheon, 134 S. Ct. at 1452; Buckley, 424 U.S. at 27–28 (1976).
268 Blount, 61 F.3d at 944–48. See also 15 U.S.C. 78o-3(b)(6).
269 SEC Pay-to-Play Adopting Release, 75 FR at 41022, 41053–54.
57
and open markets by requiring investment advisers and their placement agents to “play the
game” or risk being left out.270
In short, while FINRA’s rule resembles other contribution
limitations by serving a government interest in discouraging quid quo pro corruption, it is a
targeted effort that should protect investors and the public by promoting the integrity of the
investment advisory market.
FINRA’s proposed rule advances this important governmental interest because the two-
year time-out discourages pay-to-play. As explained above, pay-to-play has been and is a
serious problem when placement agents assist investment advisers in obtaining advisory business
from government entities.271
Placement agents “played a central role in actions that [the
Commission] and other authorities have brought involving pay-to-play schemes,” and, in several
instances, advisers used placement agents, who had made campaign contributions to elected
officials, to influence the award of investment advisory contracts.272
Most notably, Alan Hevesi,
the Comptroller of New York State who was responsible for investment of state pension funds,
accepted campaign contributions from a placement agent and steered over $250 million in
pension funds to investment advisers that had retained the placement agent.273
In response to these incidents, the Commission proposed a ban on the use of placement
agents by investment advisers and ultimately adopted a final rule that permitted use of placement
agents so long as they were “regulated persons” governed by the type of pay-to-play rule that
270
Id. at 41019, 41022, 41053. See also Blount, 61 F.3d at 945–46.
271 SEC Pay-to-Play Adopting Release, 75 FR at 41019–20. Pay-to-play that affects State
and local pension funds is not limited to the investment advisory context.
272 SEC Pay-to-Play Adopting Release, 75 FR at 41019–20, 41037.
273 Id. at 41019–20.
58
FINRA has proposed here.274
FINRA is not alone in addressing these issues. For example,
several State and local governments have barred or restricted placement agents from playing a
role in the contracting process.275
Although the Supreme Court has never required a certain
amount of past quid pro quo corruption to sustain a contribution limitation, there is more than
sufficient evidence of pay-to-play practices to support FINRA’s rule.276
The contours of FINRA’s proposed rule reflect how pay-to-play practices involving
placement agents affect the hiring and retention of investment advisers by State and local
pension funds. One scenario implicated by FINRA’s rule (and reflected in the Hevesi matter)
involves an investment adviser that seeks business from a State pension fund and retains a firm,
or an individual at a firm, that has made contributions to an elected official responsible for
selecting investment advisers.277
The elected officials who participate have no incentive to stop
accepting contributions for fear of being disadvantaged relative to their opponents. Similarly
neither the placement agents that make the contributions nor the investment advisers that hire the
placement agents have an incentive to stop out of concern that if they abstain, their competitors
will continue to engage in the practice profitably and without adverse consequences.278
FINRA’s
274
Id. at 41037–42.
275 Id. at 41037 n. 262.
276 McCutcheon, 134 S. Ct. at 1445, 1458; Nixon, 528 U.S. at 390–91; Buckley, 424 U.S. at
29-30.
277 SEC Pay-to-Play Adopting Release, 75 FR at 41019–20 & nn.18–20 (citing examples).
278 Id. at 41022, 41040, 41053. See also Blount, 61 F.3d at 945–46. Even if the public is
aware of the quid pro quo relationship, there is little that can be done because the official
is compromised by the receipt of the contribution, and beneficiaries of a pension fund
cannot easily shift their assets out of the fund, reverse the hiring decision, or remove the
official. Id. at 41027. See also id. at 41053 n.459.
59
rule should resolve this collective-action problem by interposing a time-out that creates a
disincentive to engage in pay-to-play.
The proposed FINRA rule, like the SEC Pay-to-Play Rule that it is modeled on, is a
tailored solution to a particularly pernicious form of quid pro quo corruption that affects the
beneficiaries of public pension funds, such as teachers, law enforcement officers, firefighters,
and other public servants, as well as the beneficiaries of other collective government funds,
including participant-directed plans such as 403(b), 457 and 529 plans. The proposed FINRA
rule would affect a small segment of the electorate: in general, member firms acting as placement
agents for investment advisers seeking to obtain advisory business from government entities.
And the proposed FINRA rule would affect only a small number of elected officials—those who
are responsible for or have authority to appoint any person who is responsible for or can
influence the outcome of the hiring of an investment adviser by a government entity—and has no
bearing on the vast majority of elections where the elected office’s scope of authority does not
encompass the awarding of investment advisory contracts. Moreover, the proposed FINRA
rule’s de minimis exception permits some campaign contributions to be made in all instances
without triggering the time-out—thus allowing “the symbolic expression of support evidenced
by a contribution”—and it does not restrict other forms of political speech, such as independent
expenditures.279
B. Comments Regarding the Scope and Coverage of the Proposal
As discussed in detail above, the commenters raise several concerns regarding the scope
and coverage of the proposed rules, including with respect to: the inclusion of variable annuities
279
McCutcheon, 134 S. Ct. at 1444, quoting Buckley, 424 U.S. at 21 (internal quotation
marks omitted).
60
and mutual funds;280
the inclusion of distribution activities;281
the application to covered
investment pools;282
the level of the de minimis contribution exception and the returned
280
See CAI Letter 1 and FSI Letter 1. See also CAI Letter 2 (reflecting CAI’s suggested
revisions to certain language in some of FINRA’s proposed rules). In FINRA’s view,
because the Commission did not exclude specific products from the SEC Pay-to-Play
Rule, such as variable annuities or mutual funds, excluding specific products from its
proposed rule would not satisfy the Commission’s stringency requirements. See FINRA
Response Letter 2 at 16.
281 See CAI Letter 1. See also CAI Letter 2 (reflecting CAI’s suggested revisions to certain
language in some of FINRA’s proposed rules). FINRA notes that, among other things,
language in the SEC Pay-to-Play Rule Adopting Release supports the inclusion of
“distribution” activities by broker-dealers in FINRA’s proposed Rule 2030(a). See
Notice, 80 FR at 81660–61 (citing SEC Pay-to-Play Rule Adopting Release, 75 FR at
41040 n.298 where, according to FINRA, the Commission “clarif[ied] under what
circumstances distribution payments would violate the SEC’s Pay-to-Play Rule”).
FINRA believes that based on the Commission’s definition of “regulated person” in the
SEC’s Pay-to-Play Rule, as well as the Commission’s discussion regarding the treatment
of distribution fees paid pursuant to a 12b-1 plan as compared to legitimate profits, its
proposed rule must apply to member firms engaging in distribution activities. See
FINRA Response Letter 2 at 12 (citing Notice, 80 FR at 8166061) and FINRA
Response Letter 2 at 12 n.53 (explaining that the SEC Pay-to-Play Rule defines a
“regulated person” to include a member firm, provided that FINRA rules prohibit
member firms from engaging in distribution or solicitation activities if political
contributions have been made, and citing SEC Pay-to-Play Rule 206(4)-5(f)(9)(ii)(A))
(emphasis in original).
282 See CAI Letter 1; FSI Letter 1; FSI Letter 2. FINRA clarifies that it is not intending in
this proposal to re-characterize broker-dealers’ selling interests in variable annuities,
mutual funds, and private funds as soliciting an investment advisory relationship with
investors who invest in those products. See FINRA Response Letter 2 at 14–15 (noting,
for example, that the applicability of proposed FINRA Rule 2030(d) is for purposes of
FINRA’s pay-to-play rule only). FINRA also explains that FINRA Rule 2030(d) is
modeled on a similar provision in the SEC Pay-to-Play Rule, Rule 206(4)-5(c) and, as
such, proposed FINRA Rule 2030(d) is intended to extend the protections of the proposed
rule to government entities that access the services of investment advisers through hedge
funds and other types of pooled investment vehicles sponsored or advised by investment
advisers. See FINRA Response Letter 2 at 15 (noting that when adopting SEC Pay-to-
Play Rule 206(4)-5(c), the Commission stated that although “an investment in a pooled
investment vehicle may not involve a direct advisory relationship with a government
sponsored plan [that] does not change the nature of the fraud or the harm that may be
inflicted as a consequence of the adviser’s pay-to-play activity”) (quoting SEC Pay-to-
Play Rule Adopting Release, 75 FR at 41044–45). Finally, FINRA notes that the
61
contribution exception;283
the inclusion of the independent business model;284
and the application
to existing contracts or accounts.285
FINRA generally responded that its proposed rules are
designed to be at least as stringent as the SEC Pay-to-Play Rule so that FINRA’s member firms
will meet the definition of “regulated persons” such that they are subject to rules that impose
substantially equivalent or more stringent restrictions on its members than the SEC Pay-to-Play
Rule imposes on investment advisers.286
As noted above, the SEC Pay-to-Play Rule, in part, prohibits any investment adviser
covered under the rule or any of its covered associates from providing or agreeing to provide,
applicability of proposed FINRA Rule 2030(d) is for purposes of FINRA’s pay-to-play
rule only. See FINRA Response Letter 2 at 15.
283 See CAI Letter 1. In response, FINRA explains that it has proposed exceptions for de
minimis contributions and returned contributions that are consistent with similar
exceptions in the SEC Pay-to-Play Rule as FINRA’s proposed rules must impose
substantially equivalent or more stringent restrictions on member firms as the SEC Pay-
to-Play Rule imposes on investment advisers. FINRA does not believe that raising the
limits for the de minimis exception or eliminating the limit for returned contributions
would satisfy the Commission’s stringency requirements set forth in the SEC Pay-to-Play
Rule.
284 See FSI Letter and FSI Letter 2. FINRA explains that the Commission did not exempt
application of the rule for firms engaged in the independent business model. See FINRA
Response Letter 2 at 16. As a result, in FINRA’s view, excluding independent business
model firms from its proposed rule would not satisfy the Commission’s stringency
requirements, although FINRA is willing to work with the industry and Commission to
address the interpretive questions and provide additional guidance as needed.
285 See FSI Letter 1. In response, FINRA explains that the Commission did not apply its rule
only to contracts or accounts opened after the effective date of the rule; therefore, FINRA
does not believe that limiting the application of its rule in the way suggested by FSI
would satisfy the Commission’s stringency requirements set forth in the SEC Pay-to-Play
Rule. However, FINRA also explains that, if the Commission approves the proposed rule
change, proposed Rule 2030(a) will not be triggered by contributions made prior to the
rule’s effective date, and that the rule will not apply to contributions made prior to the
effective date by new covered associates to which the two years or, as applicable, six
months ‘‘look back’’ applies. See Notice, 80 FR at 81656.
286 See, e,g., FINRA Response Letter 2 at 4, 16.
62
directly or indirectly, payment to any person to solicit a government entity for investment
advisory services on behalf of the investment adviser unless such person is a “regulated person,”
as defined under the rule.287
The definition of “regulated person” includes a FINRA member
firm, provided that: (a) FINRA rules prohibit member firms from engaging in distribution or
solicitation activities if political contributions have been made; and (b) the Commission finds, by
order, that such rules impose substantially equivalent or more stringent restrictions on member
firms than the SEC Pay-to-Play Rule imposes on investment advisers and that such rules are
consistent with the objectives of the SEC Pay-to-Play Rule.288
Thus, any changes to the
proposed rules that would result in FINRA’s rules not being found to impose at least
substantially equivalent restrictions on its member firms and to be otherwise consistent with the
objectives of the SEC Pay-to-Play Rule would result in a ban on such activity.
The Commission believes that it is appropriate and consistent with Section 15A(b)(6) of
the Act for FINRA to design its proposed rules to have the same scope and provisions as the SEC
Pay-to-Play Rule. If the Commission were unable to make the required stringency finding, this
would result in FINRA member firms not being a “regulated person” under the SEC Pay-to-Play
Rule and therefore prohibited from receiving compensation for engaging in distribution and
solicitation activities with government entities on behalf of investment advisers.289
287
See Notice, 80 FR at 81650 n.6, 81656. See also 17 CFR 275.206(4)-5(a)(2)(i)(A).
288 See Notice, 80 FR at 81650 n.6. See also SEC Pay-to-Play Rule 206(4)-5(f)(9). The
definition of “regulated person” also includes SEC-registered investment advisers and
SEC-registered municipal advisors, subject to specified conditions.
289 See Notice, 80 FR at 81650 n.6. See also id. at 81651, 81656 (discussing the regulatory
objectives of and statutory basis for the proposal).
63
One commenter states that the proposal is ambiguous regarding the term “distribution”
activities in Rule 2030(a).290
This term in FINRA’s proposed rule is taken directly from the
definition of “regulated person” in the SEC Pay-to-Play Rule.291
Although the term
“distribution” is not defined specifically in the SEC Pay-to-Play Rule, to preserve the identified
benefits of the rule, the Commission interprets the term broadly in the context of the SEC Pay-to-
Play Rule to mean generally engaging in any activity that is primarily intended to result in the
sale of securities.292
In view of the Commission’s prior statements regarding the term, including
those contained in the SEC Pay-to-Play Rule Adopting Release,293
we believe the term is not
ambiguous and could be applied by FINRA members for purposes of the proposed rule in a way
that is consistent with the prophylactic nature of the proposal. However, we note that in
connection with adopting the SEC Pay-to-Play Rule, the Commission did clarify under what
290
See CAI Letter 1.
291 A “regulated person,” as defined in the SEC Pay-to-Play Rule, includes a FINRA
member firm, provided that, among other things, FINRA rules “prohibit member firms
from engaging in distribution or solicitation activities if certain political contributions
have been made.” 17 CFR 275.206(4)-5(f)(9)(ii) (emphasis added).
292 By way of example in other contexts, the Commission has recognized that, because new
distribution activities may continuously evolve in the future, it would be impracticable to
develop, for example, an all-inclusive definition or list of such activities and related
expenses, and declined to do so when it adopted the SEC Pay-to-Play Rule. See Bearing
of Distribution Expenses by Mutual Funds, Investment Company Act Release No. 11414
(Oct. 28, 1980), 45 FR 73898, 73903 (Nov. 7, 1980) (“Rule 12b-1 Adopting Release”).
See also 17 CFR.12b-1(a)(2) (explaining, in the context of registered open-end funds,
that one will be deemed to be acting as a distributor of securities if they engage in “any
activity which is primarily intended to result in the sale of shares issued by such [fund],
including, but not necessary limited to, the compensation of underwriters, dealers and
other sales personnel, the printing and mailing of prospectuses to other than current
shareholders, and the printing and mailing of sales literature”).
293 See infra notes 294296 and accompanying text.
64
circumstances distribution payments would violate the SEC’s Pay-to-Play Rule.294
For example,
the Commission explained that mutual fund distribution fees are typically paid by the fund from
fund assets pursuant to a 12b-1 plan and generally would not constitute payment by the fund’s
adviser; therefore, such payments would not be prohibited under Rule 206(4)-5.295
The
Commission also explained that where an adviser pays for the fund’s distribution out of its
“legitimate profits,” the rule would generally be implicated.296
Based on the foregoing, we
believe it is appropriate for FINRA not to have specifically defined the term “distribution”
activities for purposes of its proposal.
One commenter claims that, among other things, the “lack of clarity as to the application
of the SEC Pay-to-Play Rule to [its] members’ business model, and the scope of government
officials that trigger the requirements, has led some firms to adopt aggressive compliance
programs that prohibit political contributions.”297
As discussed above, FINRA states that,
consistent with the SEC Pay-to-Play Rule, it has determined not to except from its proposed pay-
to-play rule member firms that use an independent business model.298
We note that FINRA’s
rules and the federal securities laws do not distinguish so-called independent business model
294
See SEC Pay-to-Play Rule Adopting Release, 75 FR at 41040 n.298. See also FINRA
Response Letter 2 at 12 (citing Notice, 80 FR at 81660–61).
295 See SEC Pay-to-Play Rule Adopting Release, 75 FR at 41040 n.298 (citing Rule 12b-1
Adopting Release).
296 See SEC Pay-to-Play Rule Adopting Release, 75 FR at 41040 (citing Rule 12b-1
Adopting Release).
297 See FSI Letter 1 (claiming FSI believes that the SEC Pay-to-Play Rule has inadvertently
captured non-corrupting activity and it fears that the proposed rule may do the same).
298 See FINRA Response Letter 2 at 18.
65
firms from other broker-dealer business models.299
Rather, although a broker-dealer may
organize its operations under a variety of business models, and different business models may
present unique compliance challenges, it is up to the broker-dealer to sufficiently discharge its
regulatory obligations in light of the business model it has elected, and to tailor its supervisory
system appropriately so that it is reasonably designed300
to achieve compliance with applicable
federal securities laws and regulations and FINRA rules.301
We also note that FINRA has committed to working with the industry and the
Commission to address interpretive questions that may arise regarding the application and scope
299
While a firm may accept independent contractor status for purposes other than the federal
securities laws, such treatment does not alter such person’s status as a person associated
with a broker or dealer or the firm’s responsibility to supervise under the federal
securities laws. See, e.g., Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1572–76 (9th
Cir. 1990) (en banc) (explaining that, even if a broker-dealer and registered representative
contractually agree that a representative is an independent contractor, the broker-dealer is
still required to supervise its representatives).
300 See FINRA Rule 3110(a) (“Each member shall establish and maintain a system to
supervise the activities of each associated person that is reasonably designed to achieve
compliance with applicable securities laws and regulations and with applicable FINRA
rules.”) and Exchange Act Section 15(b)(4)(E), 15 U.SC. 78o(b)(4)(E) (authorizing the
Commission to sanction a broker-dealer that “has failed reasonably to supervise, with a
view to preventing violations of” the federal securities laws and rules and regulations
thereunder).
301 Giving guidance on its supervision rule, FINRA (then-NASD) noted that to fulfill its
obligations to establish and maintain a supervisory system, a member firm must
determine the types of business it conducts, how the firm is organized and operated, and
the current regulatory requirements. See NASD Notice to Members 99-45 (NASD
Provides Guidance on Supervisory Responsibilities) (June 1999) (stating that this
analysis will enable the member to design a supervisory system that is current and
appropriately tailored to its specific attributes and structure). See also FINRA Regulatory
Notice 14-10 (SEC Approves New Supervision Rules) (Mar. 2014), at 17 n.4 (discussing
NASD Notice to Members 99-45).
66
of the provisions and terms used in the proposed rule change and to provide additional guidance
as needed.302
C. Comments Requesting Clarification of Terms and Provisions in the Proposal
Commenters asked for clarification of certain defined terms and provisions in the
proposed rule, including clarification with respect to: the term “instrumentality” as it is used in
the definition of “government entity;”303
the definition of “covered associate” and the positions
that would qualify someone as a covered “official;”304
whether a “contribution” is also a
“payment;”305
and the factors by which contributions to a PAC would trigger the proposed anti-
circumvention rule.306
In response to these comments, FINRA generally acknowledges, as did
the commenters, that these terms are defined in the SEC Pay-to-Play Rule and that FINRA
modeled the definitions in its proposal on those in the SEC Pay-to-Play Rule.307
The Commission believes that FINRA’s definition of “covered associate” in proposed
Rule 2030(g) is functionally identical to the definition of the same term in the SEC Pay-to-Play
Rule.308
The definition brings within the ambit of the rule—and its two-year “time-out”—only
those contributions made by employees of a member firm who, by virtue of their position or
302
See FINRA Response Letter 2 at 18. We note that the proposed rule does contain a
provision—modeled on an analogous provision in the SEC Pay-to-Play Rule—allowing
member firms to apply to FINRA for an exemption, conditional or unconditional, from
the proposed rule’s two-year “time-out,” and enumerates factors for FINRA to consider
in deciding whether to grant such an exemption. See Proposed Rule 2030(f).
303 See CAI Letter 1.
304 See NAIFA Letter.
305 See CAI Letter 1.
306 See NAIFA Letter.
307 See FINRA Response Letter 2 at 17, 18.
308 Compare Proposed Rule 2030(g)(2), with 17 CFR 275.206(4)-5(f)(2).
67
responsibilities, are best positioned to engage in pay-to-play activities as placement agents. It
includes “[a]ny general partner, managing member or executive officer of a covered member,”
any “associated person of a covered member who engages in distribution or solicitation activities
with a government entity for such covered member,” any associated person who supervises such
an employee, and any “political action committee controlled by a covered member or a covered
associate.” FINRA’s rule also adopts the Commission’s definition of “executive officer,” which
was designed to tailor the trigger for the time-out to those officers whose position is most likely
to incentivize them to engage in solicitation or distribution activities—and thus most likely to
incentivize them to engage in pay-to-play.309
FINRA’s definition of “official” also tracks the Commission’s definition of that same
term in the SEC Pay-to-Play Rule and, therefore, limits the rule so that a time-out is triggered
only by contributions to certain officials.310
Under FINRA’s proposed rule, the time-out for a
placement agent is not triggered by a contribution to every public official running for office; it is
triggered only by contributions to a person “who was, at the time of the contribution, an
incumbent, candidate or successful candidate for elective office of a government entity, if the
office . . . [i]s directly or indirectly responsible for, or can influence the outcome of, the hiring of
an investment adviser by a government entity” or a person with authority to appoint someone
whose office had the hiring responsibility.311
FINRA’s definition, like the Commission’s, is
309
At least one commenter points out that some entities have precluded all employees from
making contributions as a result of the Commission’s pay-to-play rule and that FINRA’s
rule will have the same effect. See FSI Letter 2. However, under FINRA’s rule (and the
SEC Pay-to-Play Rule), only certain employees’ contributions will trigger the time-out
and the rules on their face do not cover contributions by all employees. See SEC Pay-to-
Play Rule Adopting Release, 75 FR at 40131–32.
310 Compare Proposed Rule 2030(g)(8), with 17 CFR 275.206(4)-5(f)(6).
311 See supra note 310.
68
flexible enough to accommodate the myriad State and local political structures while still
limiting the reach of the rule to those officials who are responsible for or have authority to
appoint any person who is responsible for or can influence the outcome of the hiring of an
investment adviser by a government entity.312
Additionally, FINRA’s definitions of “contribution” and “payment” are functionally
identical to those same definitions in the SEC Pay-to-Play Rule.313
We note that under FINRA’s
rule, the time-out is not triggered by direct contributions to political parties. Therefore, a member
firm will not violate the time-out if it receives compensation for solicitation and distribution
activities in the wake of contributions that it or its covered associates make to a political party.
Instead, FINRA’s proposed rule only precludes a covered member from soliciting or
coordinating payments to a political party of a State or locality of a government entity with
which the covered member is engaging in distribution or solicitation activities on behalf of an
investment adviser.314
FINRA notes in response to a commenter’s request for clarification as to
312
If FINRA were to define “official” by reference to a particular title, such as
“Comptroller,” the definition would be both over- and under- inclusive. Some officials
who have hiring responsibility for investment advisers do not hold the title of
“Comptroller,” and some officials with the title of “Comptroller” do not have hiring
responsibility for investment advisers. Because we understand FINRA’s definition to
track the definition that we adopted in the SEC Pay-to-Play Rule, we note that it is the
scope of authority of the office, not de facto influence, that determines whether a
contribution will trigger the time-out. See SEC Pay-to-Play Adopting Release, 75 FR at
41029.
313 Compare Proposed Rules 2030(g)(8)-(9), with 17 CFR 275.206(4)-5(f)(1), 206(4)-5(f)(7).
314 See Proposed Rule 2030(b). This aspect of the rule serves an anti-circumvention
function, along with proposed Rule 2030(e), which makes it a violation of the rule “for
any covered member or any of its covered associates to do anything indirectly that, if
done directly, would result in a violation of this Rule.” As FINRA notes, Rule 2030(e)
precludes only intentional efforts to circumvent the time-out and a covered member
would not violate the rule’s prohibition on the receipt of compensation unless there is a
showing that the covered member intended to evade the time-out. Thus, a contribution to
a PAC—other than a PAC controlled by the covered member, which would be a “covered
69
whether each and every “contribution” (as defined in proposed FINRA Rule 2030(g)(1)) is, by
definition, also a “payment” (as defined in proposed FINRA Rule 2030(g)(9)), that the definition
of “payment” is similar to the definition of “contribution,” but is broader in the sense that it does
not include limitations on the purposes for which such money is given (e.g., it does not have to
be made for the purpose of influencing an election).315
The Commission believes that FINRA’s definitions, which mirror or are functionally
equivalent to similar definitions in the SEC’s Pay-to-Play Rule, will help to achieve the
objectives of the SEC Pay-to-Play Rule and, as described above, the requirements governing the
rules of a registered national securities association.316
The Commission believes that it is
appropriate and consistent with the Act for FINRA to encompass in its rule the same definitions
and discussion regarding its pay-to-play rules as the Commission did in adopting the SEC Pay-
to-Play Rule. The Commission emphasizes that FINRA has committed to working with the
industry and the Commission to address interpretive questions and provide additional guidance
as needed.317
associate” for purposes of the time-out—would not trigger the time-out and the receipt of
compensation in the wake of that contribution would not violate the rule unless it can be
shown that the covered member or covered associate who made the contribution intended
to circumvent the time-out provision. This provision, which is analogous to a provision
in the Commission’s Pay-to-Play Rule, precludes a member or its covered associates
from, for example, funneling contributions or payments through third parties, such as
attorneys, family members, or friends, to complete a pay-to-play arrangement without
triggering the time-out.
315 See FINRA Response Letter 2 at 17.
316 See SEC Pay-to-Play Rule Adopting Release, 75 FR at 41042–44.
317 There are several ways for industry members to obtain guidance from FINRA about the
application of its rules. Such guidance may include FINRA’s publication of Notices to
Members and Regulatory Notices, as well as interpretative and exemptive letters.
Although FINRA can address interpretive questions with respect to its own rules, for its
member firms to satisfy the “regulated person” definition in the SEC Pay-to-Play Rule,
70
D. Comments Regarding the Books and Records Requirements
One commenter claims that not all payments to political parties or PACs should have to
be maintained under the books and records requirements of proposed Rule 4580.318
In response,
FINRA states that it has determined to retain the recordkeeping requirements as proposed in the
Notice.319
FINRA notes that, as discussed in the Notice, payments to political parties or PACs
can be a means for a covered member or covered associate to funnel contributions to a
government official without directly contributing.320
FINRA states that it proposed requiring a
covered member to maintain a record of all payments to political parties or PACs because such
records would assist FINRA in identifying situations that might suggest an intent to circumvent
the rule.321
the Commission must find that FINRA’s pay-to-play rule (i) imposes substantially
equivalent or more stringent restrictions on member firms than the SEC Pay-to-Play Rule
imposes on investment advisers and (ii) that such rule is consistent with the objectives of
the SEC Pay-to-Play Rule. See supra note 22 (discussing the Commission’s notice of
stringency findings dated August 25, 2016). Given the stringency requirements of the
SEC Pay-to-Play Rule, we expect our staff to work closely with FINRA regarding
interpretive questions about the application and scope of the provisions and terms used in
FINRA’s rule to the extent those interpretations do not otherwise require FINRA to file a
proposed rule change with the Commission pursuant to Section 19(b) of the Act and the
rules and regulations thereunder.
318 See CAI Letter 1.
319 See FINRA Response Letter 2 at 20–21.
320 See id. As FINRA explains in the Notice, a covered associate would include a PAC
controlled by the covered member or any of its associates. FINRA states that it would
consider a covered member or its covered associates to have “control” over a PAC if the
covered member or covered associate has the ability to direct or cause the direction of
governance or operations of the PAC. See Notice, 80 FR at 81653, 81660 (noting that
this position is consistent with the position taken by the Commission in connection with
the SEC Pay-to-Play Rule) (citing SEC Pay-to-Play Adopting Release, 75 FR at 41032).
321 See FINRA Response Letter 2 at 20. FINRA states in the Notice that the proposed
recordkeeping requirements are intended to allow FINRA to examine for compliance
with its proposed pay-to-play rule, and the reference to indirect contributions in proposed
Rule 4580(a)(4) is intended to include records of contributions or payments a covered
71
The Commission acknowledges the comment, but agrees, as noted by FINRA, that
payments to political parties or PACs can be a means for a covered member or covered associate
to contribute indirectly to a government official in contravention of the proposed rule. The
Commission also agrees that requiring FINRA members to maintain a record of all payments to
political parties or PACs would assist FINRA in identifying situations that might suggest an
intent to violate proposed Rules 2030(b) and 2030(e).322
The Commission therefore believes that
it is appropriate and consistent with the Act for FINRA to require its members to keep records of
all such payments to assist FINRA in carrying out its regulatory responsibilities to enforce
compliance with the Act and with FINRA’s rules.323
E. Additional Comments
Certain commenters also suggested that FINRA should include more stringent
requirements in its proposed rule.324
Both commenters suggested that FINRA expand the
applicability of its proposed rules to include state-registered investment advisers.325
In response,
member solicits or coordinates another person or PAC to make under proposed Rule
2030(b). See Notice, 80 FR at 81663.
322 We note that proposed Rule 2030(e) would require a showing of intent to circumvent the
rule for such persons to trigger the two-year “time-out.” See Notice, 80 FR at 81654.
See also SEC Pay-to-Play Rule Adopting Release, 75 FR at 41044 n.340 (explaining that
like MSRB Rule G-37(d), SEC Pay-to-Play Rule 206(4)-5(d) also “requires a showing of
intent to circumvent the rule for such persons to trigger the time out”) (citing Blount, 61
F.3d at 948 (“In short, according to the SEC, the rule restricts such gifts and contributions
only when they are intended as end-runs around the direct contribution limitations.”)).
323 Section 15A(b)(2) of the Act requires, among other things, that a registered national
securities association, such as FINRA, has the capacity to enforce compliance by its
members and persons associated with its members with the provisions of the Act, the
rules and regulations thereunder, and the rules of the association. See 15 U.S.C. 78o-
3(b)(2).
324 See NASAA Letter and PIABA Letter.
325 See NASAA Letter and PIABA Letter.
72
FINRA explains that to remain consistent with the SEC Pay-to-Play Rule, FINRA has
determined not to expand the scope of the proposed rule as suggested by commenters to include
state-registered investment advisers.326
The Commission acknowledges this comment but believes that it is appropriate for
FINRA to determine to provide for the same scope of its pay-to-play rule as that of the SEC Pay-
to-Play Rule. As FINRA notes, the Commission previously declined to make a similar change to
the SEC Pay-to-Play Rule stating, among other things, that it was the Commission’s
understanding that few of these smaller state-registered firms manage public pension plans or
other similar funds.327
These same commenters suggest that FINRA include a mandatory disgorgement
provision for violations of its proposed rule.328
In response, FINRA explains that it determined
not to include a disgorgement requirement in its proposal because it has existing authority to
require disgorgement of fees in enforcement actions.329
The Commission believes that it is
appropriate and consistent with the Act for FINRA not to separately require mandatory
disgorgement for violations of its proposed rules.
326
See FINRA Response Letter 2 at 10.
327 See Notice, 80 FR at 81652 n.26, 81660 n.98. See also SEC Pay-to-Play Rule Adopting
Release, 75 FR at 41026, 41060. The Commission also explained in connection with the
SEC Pay-to-Play Rule that we do not have regulatory authority to oversee the activities of
state-registered advisers through examination and our recordkeeping rules, nor does the
Commission have authority over the states to oversee their enforcement of their rules.
See SEC Pay-to-Play Rule Adopting Release, 75 FR at 41026, 41060.
328 See NASAA Letter and PIABA Letter.
329 See FINRA Response Letter 2 at 19–20.
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Finally, one of these commenters suggests that the current two-year cooling-off period in
the proposal should be at least four years.330
In response, FINRA states that it believes a two-
year time-out from the date of a contribution is sufficient to discourage covered members from
participating in pay-to-play practices by requiring a cooling-off period during which the effects
of a quid pro quo political contribution on the selection process can be expected to dissipate.331
In addition, FINRA explains that the proposed two-year time-out is consistent with the time-out
period in the SEC’s Pay-to-Play Rule. The Commission believes that it is appropriate and
consistent with the Act for FINRA to determine that a two-year time-out is sufficient to support
the objective of the rule to deter pay-to-play activity among its covered members. The
Commission notes that the same time period applies in the SEC’s Pay-to-Play Rule.
The Commission recognizes these commenters suggest that the rule could have a broader
scope. The Commission, however, must evaluate the proposed rule before it and approve a
proposed rule if it finds that the proposed rule is consistent with the requirements of the Act and
the applicable rules and regulations thereunder. As discussed above, because the rule is
consistent with the Act, the Commission is required to approve the FINRA rule.
330
See PIABA Letter.
331 See FINRA Response Letter 2 at 10. As the Commission explained, the two-year
“cooling-off period” is not a penalty but, rather, is intended to be a period during which
any effects of a quid pro quo are expected to dissipate. See SEC Pay-to-Play Adopting
Release, 75 FR at 41026 n.104.
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V. Conclusion
Accordingly, for the reasons discussed above, the Commission finds that the proposed
rule change is consistent with the Act and the rules and regulations thereunder applicable to such
organization.
IT IS THEREFORE ORDERED, pursuant to Section 19(b)(2) of the Act,332
that the
proposed rule change (SR-FINRA-2015-056) be, and hereby is, approved.
By the Commission.
Brent J. Fields
Secretary
332
15 U.S.C. 78s(b)(2).